Five ways to reduce your inheritance tax

Friday, December 04, 2009 | Posted by: Sue Knight
Categories: Protecting your wealth | Tags: inheritance tax, Sue Knight, pensions, IHT, debt, planning, banks, trusts, assets, trust wrappers, IHT threshold, public sector debt, asset protection, bailout

Inheritance tax (IHT) is an emotive topic, not just for those who have saved for a lifetime but also for their accountant who must negotiate the many rules and planning opportunities. Often described as a ‘voluntary’ tax, there are a number of ways in which you can mitigate IHT and retain control over your assets and access to both income and capital. This month, I’m going to explain some of these options and look at David Cameron’s election promise of raising the IHT threshold to £1 million…

Of course, many will be relying on this hope. The Conservative Party, if it comes into power next year, has promised to raise the IHT threshold from the current £325,000 to £1 million, as stated in the Conservatives policy manifesto. For married couples, this effectively means that if their combined estates are £2 million or less, then they will fall outside the IHT net.

But there are two concerns with this.

Firstly, there has already been some discussion within the Conservative Party as to whether they will be able to increase the IHT threshold given that total public sector net debt grew to £829.7 billion by 31 October 2009. This is equivalent to 59.2% of the total national output – the highest level since 1946. There is only one real way to pay down public sector debt which is to raise taxes and cut public expenditure, as discussed in my colleague Richard Jameson’s recent posts on Tax rises – the elephant in the room and Raise NICs not the state pension age, and also neatly summarised in The Times. So it could be well into the first term before the promised threshold increase sees the light of day.

Secondly, as is currently the case, if an individual’s assets exceed the IHT threshold then broadly a 40% inheritance tax liability will still crystallise on death on any amounts above the threshold. 

As I noted previously in 10 strategies for tax planning in 2009, with the new 50% income tax rate band and a further 40% IHT on death, the effective tax rate for some high earners will rise to 70%. (For example, on £100 earned income taxed at 50%, you would be left with £50. If this was then subject to 40% IHT, your IHT bill would be £20 – a total tax of £70 equating to a 70% rate just on earned income in the new higher rate band.)

So, what options are available to families who still face a hefty IHT charge on death?

1 Purchase a cash trust
Individuals wanting to retain access to income and capital could consider purchasing a trust with cash assets. After a maximum period of six months, and it could well be less than this, the cash falls out of the individual’s estate, thereby saving IHT at 40%, and the individual still has access to the income and capital. Broadly, the trust will be subject to IHT at a maximum rate of 6% every 10 years, based on current rates.

2 Create a debt
Individuals with assets which do not qualify for any IHT reliefs, such as equity portfolios, main residences, investment properties, and so on, could create a debt to set against the asset, which could be gifted to their heirs, thereby reducing the value in their estate so that only future growth in value of the asset is subject to IHT at 40%. Again, this planning can be structured to allow the family to retain control of the asset and access to income and capital. The planning does require the individual to survive seven years from the gifting of the debt but some IHT saving is achieved at outset.

3 Reassign low-value assets
Where assets, such as shares or property, are currently low in value, this may be a good opportunity to ensure that future growth accumulates outside an individual’s estate and passes into a trust for the next generation. It should be possible to achieve this without crystallising any tax charges. This idea can be combined with ‘create a debt’ (above) to ensure that both the current and future value of the asset falls outside the individual’s estate on death. 

4 Put up to £3 million in trust
It used to be that individuals could make gifts into certain types of trusts without crystallising an IHT charge. The position changed with effect from 22 March 2006 and now the majority of trusts created during an individual’s lifetime will be subject to IHT at 20%. Trusts are often used to protect family wealth as individuals are often reluctant to pass significant wealth to their children for fear of divorce, bankruptcy issues and so on. Planning is now available that enables amounts of up to £3 million to be settled on trust without crystallising an immediate IHT charge, thereby enabling assets to be gifted to the next generation via a trust wrapper.

5 Trusts to avoid the seven-year hitch
Trusts can also be used to enable gifts to be made without the need to survive the usual seven-year period, which is useful for those who have left their planning to the last minute or for those who need to plan sooner than they expected. The individual creates a trust, which they gift to their chosen heirs without crystallising any tax charges. The funds can remain in the trust, providing a degree of asset protection going forward. 

All of the above solutions are dependent on individual circumstances and require a tax specialist’s input. Planning to reduce IHT liabilities enables individuals to take control of their finances at a time when the economic outlook is still uncertain, thereby providing greater certainty and financial prosperity for the next generation. 

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For help with IHT planning, see our Personal Tax & Financial Planning page.

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Image: Money Casket at National Museum of Funeral History Houston, Texas. © Mr Kimberley