Four ways to cut down your IHT bill

Nearly £5 billion of inheritance tax (IHT) was collected in 2016/17, more than double the £2.3 billion received by the taxman in 2009/10 when the current nil rate band of £325,000 was introduced. However, there are various ways – some more familiar than others – to ensure you don’t leave an IHT liability.

Exemptions, such as the annual £3,000 gift allowance and as many gifts of up to £250 per person as you like, allow you to chip away at a future liability. Alternatively, you can simply give away assets on the assumption that you will survive a further seven years and they will therefore fall out of your estate.

But these do not necessarily offer a complete solution, as you’re giving away assets that you may need when you’re older; moreover, the latter option requires that you have time on your side. As Jonathan Drysch, associate director at Killik & Co, explains: ‘If you have a larger liability or you don’t want to give away money outright, you may need to consider other options.’

1) Normal gifts out of income

Although it is one of HMRC’s exemptions, the ‘normal gifts out of income’ option doesn’t get used as much as it should. ‘This is seriously underutilised,’ says John Humphreys, head of sales at Way Investment Services. ‘If you have surplus income, you can give this away and it will be immediately out of your estate for IHT purposes.’

There are some conditions attached. The gift needs to be regular and come out of your taxed income. In addition, giving away the money mustn’t affect your normal standard of living.

Importantly, as the exemption can’t be claimed until after your death, it’s essential to document these gifts. ‘Write down what you gifted and to whom, and share the details with your executors,’ adds Drysch. ‘You can reduce your estate significantly with this exemption, but you do need to commit to making the gift indefinitely and keep records of it.’

2) Trusts

Trusts can also have a valuable part to play in your IHT planning, especially where you don’t want to give the money away outright – for instance, if the recipient is too young. With any trust, you’ll need to live seven years for the money to be outside your estate for IHT purposes and it’s also prudent to keep settlements below the nil rate band. ‘Pay in more and you’ll face a 20 per cent IHT charge on the excess on the way in,’ says Drysch. ‘There’s also a periodic charge of 6 per cent on any excess every 10 years.’

As well as giving you more control over when your beneficiaries receive the money, there are also variations that enable you to access the money you put into trust, without affecting the IHT benefits.

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A ‘gift and loan’ trust allows you to take withdrawals from the original amount you placed in trust – the loan. Although this element remains in your estate, any growth is immediately outside it for IHT purposes. Joe Sanders, chartered financial planner at Informed Financial Planning, explains: ‘This can work if you’re concerned you might have an IHT problem in the future, or you don’t want to make an existing liability worse.’

Another option is a ‘discounted gift’ trust. This gives you a right to a set income from the trust, with an immediate reduction in your estate for IHT purposes. This reduction – the discount – is based on factors such as your age, health and the level of income required, with longer life expectancies gaining larger discounts. As well as ticking the access box, this can be beneficial if you’re not sure you’ll live for seven years, as the discount will reduce your estate immediately.

While these options can provide useful financial planning solutions, for the ultimate freedom around access, Sanders says a ‘flexible reversionary’ trust may be worth considering. ‘Each year the trustees, which could include yourself, have the option to return some of the trust funds to you,’ he explains.

‘You don’t have to take it, or you could take less or nothing at all, and then take more in the following years. Rather than limiting your access to set withdrawals, as is the case with the discounted gift trust, or restricting it to your original investment, which you would with a gift and loan trust, a flexible reversionary trust gives you much greater freedom to take what you need.’

3) Aim portfolios

Where you’re uncomfortable gifting the money, you could consider investing in assets that qualify for business relief and therefore fall out of your estate much more quickly. Tasnim Khalid, partner and head of the estate planning department at JMW Solicitors, explains: ‘Assets that can qualify for business relief include Alternative Investment Market (Aim) shares, agricultural land including solar and wind farms, and trading businesses. Once you’ve owned them for two years, they’ll qualify for 100 per cent relief and won’t incur IHT.’

Unless you already have a business, investing in Aim shares is the commonest way to benefit from this relief. Although it’s possible to do it yourself, Paul Mumford, senior fund manager at Cavendish Asset Management, recommends taking advantage of professional advice, through either a fund specifically designed to mitigate IHT or a stockbroker.

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‘Aim shares can be volatile, so this expertise can be invaluable. Diversification is also a must, and I’d recommend no more than 1.5 per cent of your portfolio in any one share,’ he explains. ‘In addition, not all Aim shares qualify for business relief. A professional manager can monitor this on your behalf.’

While this approach reduces the length of time it takes to reduce an IHT liability, there’s a big catch, as the potential volatility of these shares means you could lose the 40 per cent you’d save in IHT and more if your investment performs badly. However, Mumford says the Aim market has changed significantly over the last few years, giving investors access to a much broader spread of sectors and relatively large, successful companies such as ASOS and Boohoo.com.

4) Whole of life insurance 

If the prospect of this level of risk leaves you cold, another option is to insure a future IHT liability. With a whole of life insurance plan, the proceeds are made available after death, allowing an IHT bill to be settled.

Sanders says the beauty of this is that it allows you to retain access to your assets. ‘If you can’t gift your wealth – for instance if it’s tied up in property, or you simply don’t want to – whole of life is a good option,’ he says. ‘As long as you’re in good health, you can take cover out up to around age 80. It’s also possible to get guaranteed rates to give you certainty around the cost of cover.’

Cover can be taken out by individuals, or by married couples, in which case the benefit is paid on second death when the IHT liability arises. As the underwriters will be assessing risk on the person with the longer life expectancy, this means it’s possible to take out a policy even when one of you is in poor health.

Although insurance can suit many people, there are some potential drawbacks. ‘You’re assessing the value of the estate today,’ says Humphreys. ‘But if someone’s in their 60s, how can you know what it’ll be worth in 25 years’ time?’ Adding indexl inking when you take out a policy will allow you to increase cover. However, if you subsequently need more, you may have to be underwritten again for the extra, which could prove prohibitively expensive.

The other potential drawback is that if a policy lapses, cover stops and you don’t get a penny back. ‘Think about affordability over your lifetime,’ says Humphreys.

5) Planning your strategy

Whether you find ways to reduce your estate for IHT purposes or opt to insure a future liability, it’s essential to review your plans regularly and make sure your will is up to date. ‘Use the exemptions where you can, but also check your potential IHT liability hasn’t shifted significantly. Legislation and wealth can change, so make sure your plans are still valid,’ says Humphreys. 

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