Inheritance Tax (IHT) planning is usually an integral part of any estate planning exercise, as most people want to ensure that as much of their property as possible passes to their family or friends.
There was speculation recently that the UK Budget on 30 October 2024 might bring significant changes, or even wholesale reform, to the existing IHT regime. This did not happen, although some important changes will be introduced, notably in relation to Agricultural Property Relief (APR) and Business Property Relief (BPR), discussed further below. There are also changes proposed regarding IHT on pensions, on which we will write further as the consultation process progresses.
However, most IHT rules, exemptions and reliefs remain unchanged following the Budget, and we take a look here at how they may be used to help people maximise the value they can pass to their chosen beneficiaries.
Broadly, there are three areas to consider:
- Making gifts during your lifetime to reduce your taxable estate on death;
- Careful will planning to take advantage of available reliefs and exemptions;
- Life insurance to mitigate the cost of any IHT charge that does arise.
THE BASICS
IHT on death is payable at 40% (20% on lifetime transfers) on the value of your property over £325,000 (the current value of the nil rate band (NRB)), except to the extent that it passes to your spouse or civil partner, or to another exempt recipient, such as a charity. The NRB that is available on your death may be reduced by any gifts you make (other than to exempt beneficiaries) within 7 years of your death.
If the whole of your NRB is not used following your death, anything left over may be transferred to the estate of your surviving husband, wife or civil partner to be used on their death. This is referred to as a 'transferable nil rate band'.
If your estate is under £2.35 million, there may be an additional NRB (the residential NRB (RNRB)) of up to £175,000 in respect of your family home if you pass it to your children, grandchildren or subsequent descendants (this gradually reduces to zero for estates valued between £2 million and £2.35 million). This is also transferable to a surviving spouse if not used up on your death.
LIFETIME GIFTS
Potentially exempt transfers (PETs)
You can make outright gifts of any value tax free, provided you survive for at least seven years following the gift. The tax payable starts to reduce once you have survived by three years and drops gradually to zero over the next four years. Such a gift is known as a 'potentially exempt transfer' (PET).
Normal expenditure out of income
If it is an option, it is possible to make regular gifts out of your surplus income, tax-free. Regularity is important, but the amounts given do not have to be the same each year, nor is there any limit on their value. The test is that gifts do not adversely affect your standard of living.
Annual allowance (£3,000)
Each tax year, you can make one or more tax free gifts up to a limit of £3,000 in total. Any unused allowance may be carried into the next following tax year, resulting in a maximum available allowance of £6,000 in any tax year.
Other allowances
There are other, more modest, exemptions available, such as one for small gifts made to any one person not exceeding £250 (provided they have not benefited from the £3,000 annual allowance).
Wedding gifts may also be made tax free. The limits are between £1,000 and £5,000 depending on your relationship to the recipient.
Points to watch
For gifts of property other than cash, capital gains tax may be payable on any gain in value since the asset was acquired.
For a gift to be successful for tax purposes, the property must be given away properly. For example, an individual must not give their house to their children, and then continue to live in it (or, at least, not without paying a market rent). Doing so is regarded as a "gift with a reservation of benefit". Not only is such a gift ineffective in removing the property from your estate for tax purposes, but may also give rise to additional tax charges, as it is effective as a gift to the recipient, so may also be taxable in their estate.
MAKING A WILL
Regardless of any tax considerations, it is vital to make a Will to ensure that following your death your property passes to the people you wish to benefit in the shares you choose. This is particularly important if you have more than one family, perhaps as a result of divorce and re-marriage, to ensure that your property is shared between your families in the shares you choose.
At the same time, however, there are a number of ways you can reduce the level of IHT paid on your estate.
Nil rate band
Use your nil rate bands. If your estate is within the £2.35 million limit, leave your family home to your children or grandchildren to take advantage of your RNRB. Consider using your NRB by giving property up to £325,000 to family members other than your husband, wife or civil partner. However, if you choose not to, don't worry as any NRB left over will be transferable to your spouse's estate on their death.
Tax relief for gifts to charity
If you leave 10% or more of your estate to charity in your Will, the IHT rate applied to the rest of your estate will be reduced from 40% to 36%. For all charitable gifts, regardless of percentage, their value is deducted from your estate before IHT is charged.
APR and BPR
For those who have specific types of property to leave – a farm or an interest in a business, including shares in an unlisted company – such property may qualify for full or partial relief from IHT, depending on the type of property you hold. The rules are complex and, as discussed above, are due to change from 6 April 2026.
Broadly, the proposal is that from 6 April 2026, each individual will have a £1 million lifetime allowance for a combination of qualifying agricultural and business property that will be eligible for 100% tax relief. Any such agricultural or business property over the £1 million limit, and shares designated as “not listed” on the markets of recognised stock exchanges - for example, those listed on AIM (the Alternative Investment Market) - will be relieved at 50%. We will write separately on the detail of the new measures.
Due to the proposed changes, and the complexity of the rules, specialist advice should be taken in relation to such property.
LIFE INSURANCE
There are many reasons why you may wish to take out life insurance, but one reason for doing so is to help pay the IHT bill on your death, if there is one. Life insurance doesn't have a role in reducing your IHT bill, but it may mitigate its effects on your family and ensure that more of the property you have worked to create and save is available to pass to them.
THINGS TO REMEMBER
Before you start any tax planning, you need to consider what you will require to maintain your own lifestyle. Bear in mind that this will hopefully be relevant for many years, and if your health does begin to deteriorate, care costs will almost certainly continue to rise. While you may want to save tax for the benefit of your family, it is vital not to focus solely on this.
Where possible, it is a good idea to discuss your financial plans with your family – early communication can prevent unpleasant, and potentially costly, misunderstandings and disagreements later.
In order to ensure your plans actually work as you intend, you should take expert legal advice. If you would like to discuss your will and tax planning requirements with a member of our Private Client team, please get in touch with your usual contact at Howard Kennedy, or with one of the team here.
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