When looking at ‘how to avoid inheritance tax’, you would generally be looking at ways to reduce the size of your taxable estate while making full and effective use of IHT reliefs and exemptions.
Inheritance tax becomes payable when the value of an individual’s estate, including gifts made by the deceased in the seven years prior to death, exceeds the prevailing nil rate band (NRB).
The NRB is currently £325,000, or £650,000 for married couples and civil partners.
Above this threshold, the estate will be liable to IHT at 40% before beneficiaries can take possession of their inheritance.
How to avoid Inheritance Tax: Define your goals
The place to start is to make an assessment of all of your assets and wealth – cash, property, shares, pensions, insurance policies etc – to ascertain whether your estate would indeed exceed available allowances.
If, on the basis of this assessment, IHT will be a bona fide threat to your estate, addressing the issue of planning strategies early can help you to legitimately reduce your IHT liability and ensure your loved ones benefit from your legacy in the way you intend.
As with any form of tax planning, your approach to inheritance tax planning should be grounded in your own wishes and objectives. For example, tying up funds in a structure to avoid IHT is unlikely to be the approach to take if the need is for you and your family to have ready access to the funds.
Issues of domicile may also need to be clarified before embarking on personal tax planning since your domicile status will have considerable bearing on your tax liabilities and the options open to you.
You may also explore options to fund anticipated IHT liability through for example life insurance, to alleviate the financial drain on your beneficiaries.
Any tax planning would need to be dealt with on a case-by-case basis, examining for example the suitability and availability of reliefs and exemptions and all options for disposing or transferring assets prior to death, which will need to be assessed in light of your personal circumstances and wishes.
For individuals asking ‘how to avoid inheritance tax’, here are some of the key considerations.
Make a will
Without a will, your assets and estate will be subject to the intestacy rules, regardless of your wishes or intentions for your estate.
Your estate will benefit from no protection or ‘shelter’, and will take the full hit of IHT liability.
Beneficiaries of your will also be determined by the intestacy rules, which may not correspond to how you would wish to share your estate.
Put simply, making a valid will is the only way to ensure your wishes are carried out.
Make full and effective use of the NRB
Each UK domiciled resident has an IHT-free individual allowance of £325,000, applied to their estate on their death.
Married couples and civil partners are able to transfer their personal NRB on the first spouse’s death to apply on the death of the second under the Transferable Nil Rate Band. This then allows a personal IHT-free allowance of up to £650,000 on the estate of the second spouse.
Since assets can be transferred and gifted between spouses IHT-free, without limits, an IHT planning concern is where the estate on the death of the second spouse will surpass the IHT allowance. IHT planning can be used to ensure the size of the estate does not breach this threshold.
How to avoid inheritance tax on property
The main residence nil rate band (RNRB) is a recent addition to the IHT planning toolkit, and permits individuals to pass on their main residence, eg family home, to ‘direct descendants’.
For the year 2018/2019, the first £125,000 of the property’s value will be exempt from IHT.
The RNRB is increasing each year by £25,000, to a cap of £175,000 in 2020/2021.
Under the current rate (May 2018), this effectively raises the individual NRB to £450,000 under the current level, or £900,000 per couple.
By 2020, the combined total of the NRB and RNRB for married couples and civil partners will be £1million.
There are however conditions attached to use of the RNRB. It can only be applied to one property. The property does not have to be the family home, but it must at some point have been a residence of the deceased. Buy-to-let properties will not qualify.
The RNRB is reduced by £1 for every £2 above the threshold where estates are over £2million.
For estates above the threshold even after RNRB and NRB are applied, a consideration of property ownership may be effective. For example, one option could be to change legal ownership of the property from a ‘joint tenancy’ to a ‘tenancy in common’. It is possible to change to tenants in common even after the first spouse has died.
Joint owners own 100 per cent of the home together – ‘jointly and severally’ – and when one dies, the other becomes the 100 per cent owner. This is the typical form of ownership for married couples. Importantly, a joint tenancy takes precedence over even a valid will where your instruction is to bequeath your share to a party other than your joint tenant.
If the joint owners are spouses, no IHT will be payable on the death of the first spouse.
If the joint owners are not married, the surviving co-owner may be liable to IHT in the usual way.
If the joint tenancy takes the value of the second spouse’s estate over the threshold, it may be advisable to split the shares in the property differently, say, 75/25, and leaving their share to someone other than their spouse, such as their children, so that when the first spouse dies, only their share of the house is counted as part of their estate.
How to avoid inheritance tax through gifting
The gifting rules allow you to transfer cash without triggering IHT while reducing the eventual size of your estate.
Individuals can gift £3,000 a year, and make unlimited small gifts of £250, free from inheritance tax.
Married couples and those in civil partnerships can gift each other unlimited amounts free of tax, provided their spouse is UK-domiciled. Special rules apply where one spouse is non-UK domiciled, we can advise on your specific circumstances. Wedding gifts are also exempt. The rules differ depending on the relationship to the couple marrying: up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else.
You can use unfettered gifting to contribute to another individual’s living costs. There is no limit on the size of these gifts, but to be deemed IHT-exempt, you must be able to show that the amount gifted comes from a surplus in your income, and is not impacting your own standard of living.
It is possible to gift unlimited amounts to other individuals, but these will be subject to the seven-year rule. These are known as ‘Potentially Exempt Transfers’.
If you survive making the gift by seven years, the money will be IHT-free. Dying before the seven year point will expose the gift to IHT at a sliding scale, starting at 40% within the first three years. This highlights the case of taking early planning action.
Gifting to charity
Gifting to charities and recognised political parties will be excluded from your estate when inheritance tax is calculated.
Gifting at least 10% of your net estate to a charity (but not to a political party) can reduce the applicable IHT rate on your estate from the standard 40% to 36%.
How to avoid inheritance tax using trusts
One of the main attractions to the trust is the degree of protection and control it provides in respect of the settlor’s wishes.
There are many different types of trust available, each with specific rules and advantages and disadvantages – it becomes a matter of working to your wishes and objectives as the asset owner as to whether a trust, and the type of trust, would be appropriate.
While it can be possible to use trusts to help to avoid paying IHT twice when passed on from your beneficiaries, gifting cash, shares and other assets into a trust will generally trigger tax liability whether IHT or Capital Gains.
For example, in the case of cash and other exempt assets, transfers into a bare trust are treated as PETs and the seven-year IHT rule will apply.
In the case of interest in possession trusts, the assets held on trust will be IHT exempt for as long as they remain in the trust and in the interest of the beneficiary.
Transfers into other types of trust are considered as Chargeable Lifetime Transfers (CLT). In the absence of any reliefs, and where the value exceeds the available nil rate band, then the excess is subject to IHT immediately at 20%. If the donor dies within seven years then there will be further tax to pay of 20%.
How to avoid inheritance tax through business
Business property relief
Business property relief (BPR) is a valuable IHT relief, offering up to 100% relief against inheritance tax on qualifying business assets, but the rules are far from straight forward.
Property investment assets are usually exposed to the full extent of IHT (and potentially CGT), making BPR a potentially lucrative form of relief.
Professional advice will be required to ensure qualifying criteria are satisfied and the requirements met.
For example, to qualify for BPR, you need to have owned a firm or shares in it for at least two years preceding your death. Not all organisations will qualify for BPR: privately owned firms and some listed on AIM, the small company arm of the London Stock Exchange, qualify for BPR. BPR can also be available on certain investment portfolios.
Qualifying agricultural property can be passed free of inheritance tax, either as a lifetime gift or on death.
Agricultural property qualifies for Agricultural Relief if it is land or pasture that is used to grow crops or to rear animals intensively. Exclusions do apply and you are advised to seek guidance on eligibility and application of the rules. The property must have been held and occupied for at least two years by the owner or their spouse, or seven years by someone else, and be part of a working farm in the UK or European Economic Area.
Agricultural relief is only given on the value of the property on the assumption that it can only be used for agricultural purposes; this is known as the ‘agricultural value’.
How to avoid Inheritance Tax with professional advice
There are many opportunities to protect your assets from IHT. However, like any form of planning, the starting point will be your personal and commercial objectives. Take professional advice to help with your inheritance tax and estate planning and ensure you are considering all options available to you across the planning spectrum, considering reduction in the size of the taxable estate or making full use of IHT reliefs and exemptions.