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Inheritance tax – a tax of choice?

Updated 22 December 2022

3min read

Marcus Dodds

Does it look as if your estate is large enough to be subject to inheritance tax? If you take action soon enough, you may find you have the power to change that. Marcus Dodds, Financial Planning Consultant at Armstrong Watson, explains how.

If you asked your friends, ‘Who do you want to leave your money to when you die?’ some of them might say, ‘The taxman’ – but only if they have grown-up children who work for HMRC. Otherwise, it’s safe to say that most of us would prefer our families to inherit as much of our wealth as possible.

However, the reality is that more and more people are falling into the inheritance tax (IHT) bracket. The revenues raised through IHT continue to rise, and for the first time have exceeded £5bn. The office of National Statistics published figures in June 2017 showing that the Government collected £5.1 billion in IHT in the 12 months up to May this year, which is up 9 per cent on the £4.7 billion collected just 12 months earlier. And it’s still going up. In April and May 2017 the tax receipts exceed £0.5 billion each month, and if this trend continues the total figure could hit £6 billion fairly soon.

So what’s causing this – seeing that actual incomes aren’t rising very much? The main culprits are increases in house prices, coupled with the strong performances of global stock markets. Usually we see these as good news, but where estates are concerned it can result in a hefty tax bill where previously there would have been none. In other words, it’s no longer just the wealthy who are paying IHT.

How IHT works

IHT is payable at a rate of 40 per cent on the value of your estate above £325,000, or £650,000 if you’re married, in a civil partnership or widowed. This amount is known as the Nil Rate Band (NRB) and is the limit that an individual has before triggering an IHT liability when they die. The NRB has been frozen at £325,000 for some years now, but help has come in the form of an additional main residence nil rate band of £100,000, effective from April 2017. This is due to rise each year until it reaches £175,000 per person by 2020, meaning that an individual has the ability to pass on up to £425,000 without paying IHT.

Unfortunately, not everyone is able to benefit from the new allowance as you can only use it if you are passing your main residence to ‘direct descendants’ such as children or grandchildren. If you don’t have any direct descendants then you will not qualify for the allowance.

The good news is that there are legitimate exemptions and allowances to help reduce any potential liability to IHT – which have led some to describe it as a ‘voluntary’ tax. Here’s how you can minimise or even eliminate your own bill.

Simple planning methods

  1. Using your annual gift allowance – If you can afford to give some of your money away, you can make gifts of up to £3,000 per annum. If you are the parent of a bride or groom you can also give away up to £5,000. For grandparents or other relatives this figure reduces to £2,500. Gifts to registered charities or political parties are exempt.
  2. Life Insurance – although not reducing your IHT liability directly, taking out an insurance policy and placing it in the appropriate trust enables the proceeds of the policy to be paid out on death. This means the funds will form part of your estate and will not therefore be subject to IHT (or probate) and the funds can then be used towards the payment of any IHT bill.
  3. Trusts – There are a number of different options available in using trusts and you will still have full control of the funds in most cases, but they do require you to gift money away. Many investment arrangements can be placed into a trust which can also help to reduce or even eliminate your IHT liability. Trusts can be complex and varied so it’s important to seek professional advice as there may be additional implications.
  4. Draw up a will – A surprising number of people don’t have a will. This means if you die without a will -referred to as dying intestate – your entire estate will be divided based on a pre-defined formula and you will have no say in who receives what or how much tax is paid. Professional advice is a must to ensure your will is drafted in accordance with your wishes.

The above list isn’t exhaustive, and some of the areas (trusts in particular) will definitely require the help of an independent financial adviser. Seeking professional advice at an early stage can mean the difference between passing your estate to your friends and family, or handing over a large proportion of it in tax. It’s an easy choice, really, isn’t it?

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About the author
Marcus Dodds
Marcus Dodds is a Financial Planning Consultant with Armstrong Watson Financial Planning.