What is Inheritance Tax?
Inheritance Tax is levied on the estate of a deceased person. It’s a 40% tax paid by the executors, for the beneficiaries, who receive assets and properties, from the deceased’s estate.
Inheritance Tax is calculated based on the estate’s value, and not all estates are subject to Inheritance Tax.
Exemptions and allowances can reduce, or eliminate, the amount that is paid.
Inheritance Tax can be complex, and you should seek professional advice to ensure you utilise all the options, allowances, and strategies available to minimise death duties.
How to legally avoid paying Inheritance Tax
The answer is simple, the process can be complicated, but our Chartered Tax Advisors take care of all that
Inheritance Tax in the UK can be entirely voluntary, and payable only by those who aren’t inclined, or can’t be arsed, to plan ahead for it..
There are 3 problems; inaction, control and ownership. Of those, inaction is by far the most common and difficult to plan for!
You have two options. You can choose to stay as you are, and HMRC will confiscate 40% of everything when you die, or you can choose to take action, plan ahead entirely within the law, and aim to keep 100% for your family
The irony is that, by not choosing, you are choosing!
The problem is, we have been taught to be ‘careful because we might make the wrong decision’. We are afraid that the ‘wrong decision’ will deprive us of something that the’ right decision’ will bring
Well, in Inheritance Tax planning, no decision will deprive your family, and loved-ones, of 40% of everything you spent your entire life creating
Real security is not about having things, it’s about handling things. You need to fix your mindset, and take action..
To demonstrate why you should plan we’ve outlined the real costs, to your family, of you doing nothing. Read on, Macduff..
How Inheritance Tax works: thresholds, rules and allowances
HMRC’s details all the Inheritance Tax thresholds, rules and allowances are here: https://www.gov.uk/inheritance-tax
That’s factual, and dull. What’s likely much more useful to you is a simple worked example of an actual case, so you can understand for yourself, what happens to your family, if you don’t take action
Contain your excitement a little longer. It’s in a couple of paragraphs’ time, and you may be horrified..
When is Inheritance Tax payable?
Death is a convenient time for HMRC to tax your lifetime’s work. The clock starts to tick the day you die, and stops 6 months later, when Inheritance Tax is due and payable
It’s the last opportunity they get to tax you, and they’re going to take it, big time – unless you plan ahead
If you can’t be bothered to plan, then answer this question: ‘How are my family, and loved ones, going to be able to pay my death duties?’
We’ll get to that..
How much Inheritance Tax will my family have to pay?
Good question, let’s get you a quickanswer, so you can get on with your day if it doesn’t apply to you:
If you’re single and own assets of more than £325,000 (that’s the ‘nil-rate-band’) there’s Inheritance Tax to pay.
If you, and your spouse or civil partner, own assets of more than £650,000 (that’s two ‘nil-rate-bands’) there’s Inheritance Tax to pay.
In some specific circumstances, there’s an additional ‘Residence Nil Rate Band’ Allowance. Check it out for yourself: https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm46000.
Everything above those thresholds, is taxed at 40%. So, to calculate your family’s exposure to Inheritance Tax, do this:
- List all your assets, and their current values
- Deduct the nil-rate-band(s), outlined above
40% of that figure will be confiscated by HMRC as Inheritance Tax, unless you plan!
Ouch!
Let’s look at a case study example of Inheritance Tax due?
Tess died recently, just a few years after her husband, Frank. Their total estate was c£5m so, let’s take a look at the numbers:
A total estate of c£5m, less two nil rate bands totalling £650,000, leaves an £4,350,000, which is subject to Inheritance Tax, at 40%
Here’s how it played out:
HMRC confiscated £1,740,000 (£4,350,000 x 40%)
Frank and Tess’s daughters were left with £3,260,000 (£5,000,000 – £1,740,000) to be shared between them
On the face of it, that’s a lot of money, but take a closer look..
Children are subject to a 40% Inheritance Tax!
Tess and Frank have 5 daughters.
So, each of them received £652,000 (£3,260,000 / 5).
Which means that HMRC confiscated almost as much in Inheritance Tax, as three of their daughters inherited.!
That’s never what Tess and Frank intended when they started out, or at any stage throughout their lives when they worked hard, every day, to create their family legacy. Worse, they didn’t need to pay any of it, but they didn’t plan ahead
Let’s run with this a little further.
What options are there to pay Inheritance Tax?
Inheritance Tax is payable 6 months after you die and has to be paid before probate is granted
Here’s the problem:
None of their daughters had any other assets of real value, so each of them struggled with how to pay their share of Mum and Dad’s death duties
Each daughter had to pay £348,000 (£1,740,000 / 5) in death duties to HMRC, before receiving their share of their parents’ legacy
They were faced with two options; pay the tax authority at the end of 6 months or, in the case of property (and some shares), the tax authority will permit ‘time to pay’
So let’s take a look at those options
Selling your property portfolio to pay Inheritance Tax
The family’s investment properties are a typical buy-to-let portfolio, still with some of the original loans outstanding, but Mum and Dad wisely refinanced, a couple of years back, at fixed rates of less than 1%. Obviously, they wanted to keep those arrangements in place
Right now the UK residential property market is in a state of flux, with buy-to-let properties apparently less desirable than a few years ago, and market prices in their area, significantly lower than this time last year
Property professionals advised the daughters ‘not to sell at this time’ and they concluded that ‘market conditions, and timing, were against attempting hasty sales, prices were too low and, in any case, that’s absolutely not what Mum and Dad would have wanted!’
What if I can’t sell my properties to pay Inheritance Tax?
Well, HMRC allows Inheritance Tax to be paid over up to 10 years
With no other option, it means each daughter is effectively taking on a 10 year, capital and interest mortgage of £348,000, and that’s in addition to their current mortgages
So let’s delve a little deeper..
Remember, each of the girls owes HMRC £348,000 in death duties which they’ll pay in 10 equal annual instalments
HMRC’s ‘official rate of interest’ for Inheritance Tax owing is 7.75% (August 2023)
Assuming HMRC’s interest rates remain static then, each year for 10 years, each of Frank and Tess’s 5 daughters has to pay £34,800 in Inheritance Tax PLUS, £24,273 in interest at the beginning of year 2 (see calculations here)
Check it out for yourself: https://www.gov.uk/paying-inheritance-tax/yearly-instalments
What the girls wanted, of course, was closure. What each of them got, was a ten year capital and interest mortgage, to pay £348,000 plus interest, for their parents death duties
So, time for reflection..
Inheritance tax in the UK is voluntary, if you plan ahead
By not planning ahead, Frank and Tess left their family an Inheritance Tax bill of £1,740,000 to which HMRC add interest, totalling £606,825
So, Tess and Frank’s lack of planning cost their 5 daughters £2,346,825
By doing nothing, their family legacy was subject to Inheritance Tax legislation
The very same Inheritance Tax legislation can be used, in advance, and entirely within the law, to arrange your estate to reduce or eliminate Inheritance Tax completely
You need motivation, and you need to take action
How to legally avoid Inheritance Tax?
First, get your head around the fact you need to plan for Inheritance Tax, and you can’t do it properly by yourself. Read that again, and let it sink in, you can’t do it yourself!
Likely, your existing advisors, however well-intentioned, won’t have the specialist, cross-professional skill sets, required to deliver the strategic outcome(s) you need. Our Chartered Tax Advisors can do it all for you
Easiest, but not necessarily best, or right, you could just give your assets to your children, survive for 7 years, and their value at the date of the gift, plus any growth, is outside of your estate for Inheritance Tax
But who knows what the future holds. What if you’ve given assets away and your circumstances change? You’ve not only given up ownership, you’ve given up control, and that might be important to you
Typically, the biggest problem is your desire to retain absolute ownership of family wealth, until the day you draw your final breath. Well, it may be possible to retain control, and plan for Inheritance Tax, depending on the type and nature of your assets. More on that later
Be brutally honest with yourself, and involve your family in your planning
Remember, Inheritance Tax planning is not ‘all or nothing’. Likely the best solution is a mix and match of all the many planning options available to you
Control versus Ownership in Inheritance Tax planning
Effective Inheritance Tax planning for your family likely means you should consider giving up some degree of ownership of your assets
That does NOT mean you have to give up everything, or even significant control
It is possible, even with a minority interest in a company or partnership, to retain control through the partnership, or shareholder agreement and company articles
In the right circumstance, the retained interest(s) may benefit from Inheritance Tax Business Relief or from Agricultural Property Relief
Inheritance Tax and family succession
Whether you like it or not, your children will be wondering what will happen when Mum and Dad die? What are their plans for succession, and how can we possibly pay the Inheritance Tax?
The best planning means constructing a plan so that all of your assets survive you, and pass to your children and loved ones, intact. It’s your family legacy, and it’s everything you worked your entire life to create, so you owe it to yourself to get it right
Well the good news is, it’s not only possible, with the right tax specialists it’s easy, and it’s entirely legal
Using gifts and exemptions in Inheritance Tax planning
Start with a properly constructed and executed Will that accurately reflects your current wishes, in conjunction with utilising all possible exemptions and allowances. Of course, Inheritance Tax is only one reason for making your Will
Maximise use of ‘nil-rate-band’ and ‘residence-nil-rate-band’ exemptions, if applicable
Maximise gifts and exemptions (see https://www.gov.uk/inheritance-tax). Focus on ‘gifts out of normal expenditure’.
Gifting can be complicated, and can be to individuals or to a Trust. Properly constructed Trusts may enable you to retain some control and can be tax-efficient. Most importantly, your gift needs to be genuine. It is important to understand the Inheritance Tax and Capital Gains Tax implications of transferring assets into Trust, and you really must consult a practicing tax expert
Using Trusts in Inheritance Tax Planning
Trusts are an essential consideration in Inheritance Tax planning
They’ve been available in the UK since the 12th century Crusades. It’s typically the core Inheritance Tax planning vehicle of very wealthy families, and the same principles likely could work for you
Inheritance Tax planning using Trusts is complex subject matter. It’s typically beyond the competence of those seeking to plan to pass their family legacy to the next generation of their family and loved ones
You must seek professional advice from a practicing Inheritance Tax specialist. If you want to research further, here’s all you need to know about UK Trusts: https://www.gov.uk/trusts-taxes/trusts-and-inheritance-tax
Our Chartered Tax Advisors typically set up a particular type of Trust every 7 seven years for all wealthy clients, in order to maximise usage of their Inheritance Tax allowances
Depending on the value of your estate, you likely need to consider Trusts and other sophisticated planning. Before we move on to that, let’s take a look at some other options
Can I do nothing and have someone else pay my Inheritance Tax?
Surprisingly enough, yes you can!
Inheritance Tax liabilities can be insured against using a ‘whole of life’ policy. It means that you could pay premiums to a life assurance contract, which pays out to your executors, funds sufficient to pay your family Inheritance Tax bill
It’s very important to keep your planning under regular review if you go this route as you must ensure the cover is sufficient to meet the Inheritance Tax liability which will arise
There are frequent changes in legislation, tax rates, etc which you must keep on top of
Do financial services products work in Inheritance Tax planning?
Well, maybe..
Regulated financial middlemen have a range of insurance based products, seemingly designed to provide a tax-efficient structure to enable you to purchase one, or more, of their unitised investments. Let’s take a look at a couple of examples
Discounted Gift Trusts and Inheritance Tax planning
A financial middleman sells you a single premium insurance bond, which is held subject to a Trust. The idea is that you receive regular income, and the balance of the fund is held for your beneficiaries
Establishing the trust is based on a ‘discounted gift’ and is really only appropriate if you require regular cash payments from your investment
The gifted element, suitably discounted, is out of your Inheritance Taxable estate after 7 years, while your retained right to receive capital payments is worth nothing for Inheritance Tax purposes, when you die
Might be viewed as another ruse by financial middlemen, seemingly aimed at facilitating the sale of their unitised investments
You’re required to establish a Discretionary Trust, and then grant an ‘interest free loan’, which is ‘repayable upon demand’. The Trustees invest your loan in a single premium bond, and you make partial encashments, within your 5% tax-deferred annual allowance, to repay your loan
Both Discounted Gift Trusts, and Loan Trusts, are useful only in very specific, and limited, circumstances. Costs and charges associated with both structures are typically very high
Be aware, there are tax-efficient alternatives to both structures
Inheritance Tax and your trading business
On the face of it the good news is, there’s no Inheritance Tax on shares in your trading business when you die
Except that if, say, you leave your shares to your spouse or civil partner in your Will when you die, then Business Property Relief may be lost because of the Spousal Exemption. A Discretionary Trust may help
Excessive cash held on the company’s balance sheet at death will likely be treated as an ‘excepted asset’, therefore potentially deemed as ‘undistributed profit’, so it may be exposed to Inheritance Tax
Some further words of caution. Selling your business could actually create a future Inheritance Tax problem and here’s why
Let’s use a case study:
Client sells her trading business for £1m, and gets Business Asset Disposal Relief (formerly Entrepreneurs Relief) on sale so paid just 10% Capital Gains Tax on the entire sale proceeds. Her ‘accountant did a great job’ and she received £900,000, which she left on deposit at her bank
Sadly, the client died around 3 years later. Her accountant had forgotten the obvious requirement to plan for Inheritance Tax on the sale proceeds, so the entire £900,000 sat firmly in her taxable estate when she died, and HMRC confiscated £360,000 (40% x £900,000)
So, the total tax paid was £100,000 (CGT) when she sold her business, and a further £360,000 (IHT) when she died, meaning the total tax bill was £460,000. That’s a composite tax rate of 46%, on the sale of a trading business!
The moral of the story is that things are not always what they seem. Take care, plan ahead, and talk to a tax expert about the entire process, not just the sale
Inheritance Tax and investment properties
The bad news is, there are no specific Inheritance Tax reliefs either for individuals who own properties or for property company shares but that’s NOT the end of the story
The good news is, our property specialist Chartered Tax Advisors work with property owners living in the UK, and for those resident/domiciled most anywhere in the world, and they deal with the tax issues and implications of all types of property transactions, including Inheritance Tax
Be aware that professional UK property investors likely can legally make significant improvements to the tax-efficiency of their existing property planning, including Inheritance Tax, Capital Gains Tax and tax on rental income
Complex Inheritance Tax Planning solutions
Our team of Chartered Tax Advisors are at their happiest when they’re working on complex Inheritance Tax planning solutions, and how those interact with your other tax issues
You’ll hear about Trusts, simple and complex, depending on your exact requirements. You may discover things you never knew about the interaction of property freeholds, leaseholds and valuations
You’ll get to know why the Relevant Property Regime might be very valuable to you
You’ll hear about types and classes of shares, and how they’re valued, now and in future
The interaction of leases and freeholds and the issues and implications of values and timings may well be relevant to your future planning
There are nearly 1,000 tax exemptions and allowances in UK legislation and, while they don’t all apply to Inheritance Tax planning, some are very effective and they’re hiding in plain sight – you just need to know where to look. Then, when you’ve got all the ingredients, you just need the recipes..
Our Chartered Tax Advisors are ex-HMRC, ex-PriceWaterhouseCoopers (PwC) and subject matter experts, from both sides of the fence
What’s the best Inheritance Tax planning?
Inheritance Tax planning is complex and requires consideration of a number of taxes, and how they interact with each other
To plan properly requires input from your existing advisors and from across the professions. Likely you’ll need comprehensive tax advice, together with legal and accounting direction and opinion
It all needs pulling together by skilled tax professionals, and underpinned by a comprehensive Will and other legal documents
You’ll feel good, and relieved, when it’s all done, but that’s not the end. During your lifetime, your planning needs regular review and maintenance, in line with changing HMRC rules and regulations and new and amended laws
There’s more, too. When you die, you need to know that a team consisting of tax, legal and probate experts will handle everything on behalf of the family and loved ones you leave behind
Your digital estate and Inheritance Tax planning
Last, but by no means least, there’s your digital estate to deal with. Your digital estate is the footprint you’re leaving online, and it’s growing daily
Your real life and your digital life, become more entwined every day, and it’s vital you have a plan for your Digital Estate when you die. If you don’t make decisions about your digital demise, then someone else will be making them for you.!
You need to create your Digital Estate Plan, and appoint a Digital Executor, to whom you provide guidance and direction about what you want done with your digital assets, and online presence, when you die.
Final words
If you’ve really read this article, likely you’ll appreciate that you need specialist tax advice to properly plan for the impact of Inheritance Tax, and to shelter from Inheritance Tax the family legacy you have spent your lifetime creating
Likely, your existing advisors aren’t good enough and you need a faster horse. At very least, you need a second opinion from specialist Chartered Tax Advisors, who do this every day of every week
For a comprehensive solution to everything we’ve considered in this article, take a look at www.legacy.partners and talk to an expert for FREE, HERE
