Could you reduce your Inheritance Tax bill this year-end?

Over the last few years, the tax receipts from inheritance tax (IHT) have been steadily rising. This is in part due to increasing property prices and wealth while the nil rate band (the threshold at which you start to pay IHT) is frozen at £325,000.

The other reason is that many of the reliefs and exemptions available are often not utilised.

IHT is broadly payable at 40% on the chargeable value of an estate above £325,000. The right tax planning for many individuals can take them out of the IHT net completely and for others there are significant savings available.

Estate planning involves making use of exemptions, lifetime giving and structuring assets to secure reliefs, including business property relief and the residence nil rate band. The general aim is to reduce the value of the chargeable estate and consequently the IHT charge on death.

Annual gifts

There are a number of reliefs and exemptions for IHT and some common ones to consider annually are:

Annual exemption – an amount of up to £3,000 can be given away each tax year and, if unused in a year, that amount can be carried forward for one year and utilised in the following tax year.

Small gifts exemption – you can give up to £250 to as many people as you wish each tax year.

Wedding gifts - £5,000 to your child, £2,500 to your grandchild or remoter issues and £1,000 to any other.

Gifts out of income – if your income regularly exceeds your expenditure, you can give away the excess as an exempt gift. To gain this relief, the gifts must be part of a settled pattern of giving or there must be evidence of the intention to make these gifts. It may be necessary to ensure that you have evidence demonstrating that the gifts have been made out of your post-tax income.

Gifts to charities or registered clubs – full exemption from IHT.

Considering the above gifts should become part of your annual tax planning, although it is also important to make sure you are leaving yourself sufficient income for your needs.

Longer term planning

In addition to considering utilising gifts on an annual basis, you should also take a look at your overall position every few years.

Potentially exempt transfers (PETs) – a gift to an individual (family or others) that is in excess of the annual or small gifts exemption. There is no immediate charge to tax and if the donor lives for 7 years from the date of the gift, it is exempt from IHT. Tapering of the IHT may apply where between years 3 and 7 after the gift.

Chargeable lifetime transfers (CLT) – this is usually on a gift to a trust. Lifetime IHT is charged at 20% on the excess over the nil rate band of £325,000.

In addition to the nil rate band that can be used in lifetime and on death, there is a residential nil rate band (RNRB) available only on death. This is a valuable relief but is restricted on estates over £2million. Where appropriate, restructuring between spouses or civil partners to ensure both are below the £2 million means the relief is available on first death and further planning before the second can mean both RNRBs can be utilised.

Trusts – while trusts have dropped in popularity in recent years, they are still a very useful tool in estate planning as they allow a degree of control over the assets after they have been given away. The settlor cannot benefit from them if they are to be effective gifts for IHT, but they can have control over what happens to them which can be particularly useful where minor children are involved, or for older children where divorce or financial difficulty is a concern.

Family investment companies – these are becoming more popular and are often being considered in place of trusts, although both can be used together.

Business relief and agricultural property relief – these are complex but can provide very significant relief from IHT so it is important to take advice and ensure you are eligible and that you can provide evidence should it be needed. There are many IHT efficient investments available which utilise business relief and agricultural property relief. Appropriate investment advice would be needed when considering such investments as the financial risk needs to be considered alongside any tax benefits.

Reduced IHT rate – the standard IHT rate is 40% but a 36% rate will apply if you leave at least 10% of your net estate to charity.

This insight was originally featured in our Year-end tax guide for 2021/22.