Minimsing the effect of inheritance tax
What you need to know
- Without proper planning, the taxman can take 40% of your wealth
- There are two keys to unlocking a successful IHT strategy – plan early and use the reliefs properly
- Trusts and family investment companies can help you pass wealth while keeping your hand on the tiller
- Keep a record of any lifetime gifts you make and ensure your family know your advisers and have access to key documents in case the final curtain falls quicker than you anticipated
After spending a lifetime successfully growing your wealth, the prospect of the taxman taking a large share of your assets on death can be frustrating.
Inheritance tax (IHT) is levied on tens of thousands of estates every year and has a headline tax rate of 40%, meaning huge sums could potentially be payable.
A record £7.1 billion in inheritance tax was raised by HM Revenue & Customs (HMRC) in the 2022-23 financial year, £1 billion more than in the previous tax year. With thresholds frozen until 2028, more families are expected to be liable for so-called ‘death duties’ in future.1
Who pays IHT, and how can you ensure that your estate isn’t one of the 27,000 which are liable for tax each year?2
In this guide we outline how IHT works, consider some of the main reliefs and suggest some succession planning strategies. Rothschild & Co does not provide tax advice and you should contact a tax adviser before making any financial decisions. We work with a network of tax experts who can help you make the best decision for your circumstances.
Understanding inheritance tax allowances
IHT is levied when a person dies and is normally paid by your estate rather than your heirs.
The first £325,000 of your estate can be passed on tax free. This is called the ‘nil-rate band’. In addition, if your deceased spouse didn’t utilise their nil-rate band then your estate may be able to benefit from their allowance as well, meaning £650,000 can potentially be passed on free of tax.
For those estates which are liable to pay, the headline rate is normally 40%. Any IHT due on death must be paid to HMRC by the end of the sixth month after the person’s passing.
Even if you’re not tax resident in the UK, you may have an IHT exposure on assets you own which are situated in the UK.
We will discuss ways to minimise IHT in a moment, but it is worth noting here that most gifts to individuals are not liable for IHT as long as the person making the gift survives for seven years.
A basic rule of succession planning is therefore to make your gifts early and pass on assets which are likely to increase in value. However, always consider the capital gains tax (CGT) consequences as this can be applied to gifts.
The key to successful IHT mitigation is to plan early and to make maximum use of the available reliefs."
Inheritance tax calculator
Calculate the amount of inheritance tax due by using the Gov.uk calculator. You need an estimate of the estate’s value (the deceased’s money, property and possessions) to calculate whether inheritance tax is due.
Passing on the family home
For many people, the family home is their main asset and this is subject to IHT, although any mortgage is deductible in calculating its value for IHT purposes.
It can be difficult to minimise IHT on your home. If you give your property away but still live there then it will remain liable for IHT.
Ways to reduce IHT include using the spouse exemption, taking out life assurance to cover the IHT bill, downsizing and giving away the spare cash realised, or using equity release.
If you leave your house to your children or grandchildren in your will, then the gift may be able to benefit from the ‘residence nil-rate band’ if your estate is below £2 million. The residence nil-rate band is a tax-free allowance of £175,000.3
Reducing your IHT bill
The key to successful IHT mitigation is to plan early and to make maximum use of the available reliefs.
A useful tool that is commonly overlooked is the ‘normal expenditure out of income’ relief. If your annual income exceeds your outgoings you can give away the excess without an IHT charge, even if the gift is to a trust. There is no seven-year survivorship condition.
Business Relief (formerly known as Business Property Relief) and Agricultural Relief, which exempt family businesses (including investments held in unquoted trading companies) and farm land respectively from IHT, are also very important. Assets need to be owned for two years before they can qualify for these reliefs so plan early.
Prudent use of the smaller IHT reliefs on a regular basis can also reduce the taxman’s share of your estate. Every taxpayer has an annual tax-free amount of £3,000 and so regular gifts should be considered. You can carry the £3,000 forward one tax year and so, if you have not used this relief before, you can gift £6,000 in the first year.
There are also reliefs available for gifts made on marriage, so consider these if you’re closely related to the happy couple.
Other reliefs to have in your armoury are assets held in a pension, which can be passed on free of IHT. In addition, if your will leaves at least 10% of your estate to charity, the rate of IHT on your estate can be reduced to 36%. Gifts left to charity are not subject to IHT.
Unlike income tax and CGT, IHT is based not on where you are resident but where you are domiciled (broadly, where you regard your homeland). It’s therefore difficult to avoid IHT simply by leaving the UK for a few years.
However, an offshore element can provide significant IHT opportunities. If you’re not domiciled in the UK for IHT purposes, you don’t pay IHT on offshore assets. Moreover, if you create what is known as an ‘excluded property’ trust before you become UK domiciled, this can provide a permanent haven from IHT.
Even if you are domiciled in the UK, if you become a non-UK resident then using UK gilts as part of your investment strategy can also result in significant IHT advantages. Our Client Advisers can help with the purchase of the gilts and connect you with tax advisers should this option appeal to you.
Passing on wealth and wisdom
This is where tax starts to go beyond numbers on a spreadsheet. Many parents want to reduce their IHT bill but are concerned that passing wealth to their children may demotivate them.
Our Client Advisers can act as a sounding board on these issues, including how to talk to your children about wealth and how other families have structured their finances.
From a tax perspective, families often address this dilemma by creating trusts so that they can continue, as trustees, to control how the monies are invested or used.
This can be particularly effective when shares in the family trading company are placed in a trust ahead of its sale. Another planning technique is to create a family trust every seven years using the nil-rate band, which ‘refreshes’ every seven years. For example, a husband and wife can put £650,000 in trust for their children tax free every seven years. Trusts do pay IHT, normally every ten years, but at no more than 6%.
It's also increasingly common for families to use a family investment company (FIC) to square the dilemma of early IHT planning and retention of control over the wealth.
Remember a will is an essential part of an IHT strategy and should be reviewed every few years, or when there is a change in family dynamics. Make sure to keep all your financial documents in order to make it easier for your heirs to manage your finances after you’re gone.
Many parents want to reduce their IHT bill but are concerned that passing wealth to their children may demotivate them."
 Inheritance tax soars as result of UK’s fiscal drag, Financial Times, 25 April 2023
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