Here are some methods you can put to use to reduce or mitigate a potential Inheritance Tax (IHT) liability.
Make Use Of Nil-Rate Bands
Married couples and registered civil partners who are UK-domiciled can transfer assets to each other during their lifetime, or when they die, without having to pay inheritance tax by making using of the spouse / civil partner exemption.
The way this works is that a survivor of a marriage / civil partnership can claim their partner’s nil rate band, in addition to their own entitlement. As the current nil-rate band is £325,000, the effective allowance can be as much as £650,000 – assuming that none of it was used on first death.
New Nil-Rate Residence Band
You can use the nil-rate residence band to pass on your main residence to direct descendants such as children or grandchildren – and this also includes step-children, adopted children and foster children.
By using it in this way, you can increase your nil rate exemption by £325,000 per person.
Introduction of Nil-Rate Residence Band
The new band will be introduced in phases starting in April 2017, as follows:
April 2017: £100,000
April 2018: £125,000
April 2019: £150,000
April 2020: £175,000
If you do not use the allowance, it can be transferred to a spouse or civil partner on death. This means that a couple could have a combined nil rate band of £lm from 2020. However, if the net value of the deceased’s estate (after deducting any liabilities but before reliefs and exemptions) is above £2m, the additional main residence nil-rate band will be tapered away by £1 for every £2 that the net value exceeds this amount.
You can use a whole-of-life assurance policy to pay the tax bill that your beneficiaries would receive as a consequence of inheriting your wealth. The policy would pay out on your death and it should be set up in trust to avoid the proceeds falling into the estate.
Because the cost of life assurance is likely to be expensive, especially for older people, you should ensure that the expense can be justified and the potential outlay in premiums is likely to be less than the potential IHT bill they are designed to cover.
Make Use Of Potentially Exempt Transfers
You are entitled to gift most of your assets, including cash and shares to beneficiaries.
However, the gift has to be outright which means you can no longer benefit from it and so this will excludes giving away your family home if you intend to continue living there – unless you start to pay a market rent.
You can gift up to £3,000 a year in order to reduce the size of your estate for inheritance tax purposes. If you did not use the £3,000 Gift Allowance in the last tax year, your current gift allowance can increase to £6,000.
You can also gift £250 to any number of people every year but it is not possible to combine this with the annual £3,000 exemption.
If you are a parent, you can gift £5,000 to your children in respect of a wedding or civil partnership. Grandparents can gift £2,500 and anyone else can gift £1,000.
Gifts to registered charities and political parties are also exempt from inheritance tax.
You can also reduce your potential IHT rate to 36 per cent rather than 40 per cent if you leave 10 per cent of your net estate (after the nil rate band has been taken into account) to a qualifying charity.
Rules Around Gift Allowances
If you intend to make gifts on a regular basis out of your income, then they can be ignored for inheritance tax purposes if they do not affect your standard of living. This can make a significant difference to wealthier individuals who might have a potential tax liability.
Pension funds can play an important role in inheritance tax planning because your pension assets sit outside of your estate for inheritance tax purposes which means your pension can be passed through the generations tax-free.
If you die before the age of 75, all payments from a pension on death are tax-free whether the benefits have been taken or not.
Make Use Of Trusts
There are a number of different trust arrangements that can be used to reduce the potential inheritance tax bill on your beneficiaries. However, using trusts in this area of financial planning can be complex and you should make sure that you consult with a professional on the matter.
Business Property Relief Schemes
Investing in assets that qualify for business property relief can reduce the size of a taxable estate. Qualifying assets must have been held for at least two years at the date of death.
Examples of these relief schemes are enterprise investment schemes or shares listed on the Alternative Investment Market. These kind of schemes are often high-risk.