Welcome

As the chapters of our lives unfold, many of us begin to contemplate the legacy we wish to leave for our loved ones.

Making sure your legacy passes on smoothly, without the weight of high taxes, is crucial for both you and your beneficiaries. This guide aims to make inheritance tax easier to understand so you can make smart choices to safeguard your life's achievements.

Despite common misconceptions, inheritance tax isn't just for the superrich. Due to rising property values, more estates may now have to deal with inheritance tax. In fact, Inheritance Tax receipts for April 2024 to October 2024 are £5 billion, which is £0.5 billion higher than the same period last year.

But here's some good news: you can take action while you're alive to deal with potential inheritance tax issues. Whether these actions are right for you depends on your personal finances and circumstances.

In this guide, we explain different options carefully, so you have the information to make informed choices.

Estate planning can seem complex, but it doesn't have to be confusing. Consulting a qualified financial adviser can help you understand your unique situation and significantly impact your estate planning.

Please note: The explanation of the 2024 Autumn budget changes is in accordance with our understanding of the law and our interpretation of it at the time of publication. The proposed reforms we will discuss have not yet been drafted in legislation; and are subject to change.

Understanding Inheritance Tax (IHT)

What is IHT?

Inheritance Tax is a tax on the estate (the property, money and possessions) of someone who’s died. The standard Inheritance Tax rate is 40%. It’s only charged on the part of your estate that’s above the Nil Rate Band threshold (£325,000).

What is included within your estate?

• Your residence and any other properties
• Savings and investments (excluding some pensions but including ISAs)
• Life insurance policies in your name
• Inherited pension funds (i.e. from a deceased parent) will be within the scope of the deceased’s estate for IHT purposes from April 2027, rather than being exempt
• Other personal assets

How do I know if I am liable to pay IHT?

You generally liable to pay inheritance tax if your estate is valued over the £325,000 Nil Rate Band threshold.

However there are certain circumstances and allowances that are important to understand in order to understand your liability beyond that, we have included the most commonly known below.

1. Residence Nil Rate Band (RNRB)

Available since 6 April 2017, the RNRB adds an additional threshold when a residence or its sale proceeds are left to direct descendants. It complements the standard NRB but reduces for estates exceeding £2 million and may involve complex calculations for downsized homes or changes in residence.

NB: It’s important to note that the RNRB is only applicable when the main residence is passed to direct descendants, and is reduced at a rate of £1 for every £2 in assets for estates over the value of £2m. Therefore, for an estate worth £2.7 or more, the RNRB would be removed completely.

2. Spousal Exemption

Spousal exemption from Inheritance Tax (IHT) covers all transfers between spouses or civil partners, whether during lifetime or upon death, provided they are UK-domiciled or deemed domiciled. This exemption ensures no IHT is payable on these transfers.

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Let's provide you with an example

Imagine a married couple or civil partners have an estate valued at £1.5 million, including their home, which they plan to leave to their children.

First let's take a look at their allowances

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Combining these, the couple has a total IHT threshold of £1 million (£650,000 from the Nil Rate Bands plus £350,000 from the Residential Nil Rate Bands).

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What is estate planning?

Estate planning is the process of deciding how to distribute assets efficiently to your beneficiaries.

When should you start thinking about estate planning?

It's important to include estate planning in your overall financial plan.

The sooner you begin, the more choices and flexibility you'll have to organise your finances, ensuring your financial security while you're alive and the smooth distribution of your assets when you're no longer here.

Don't forget to talk to a financial adviser for personalised strategies that suit your needs.

Making a Will

An important part of estate planning is making a Will. Within your Will, you can specify who will inherit your estate and other matters such as who will look after your children if relevant.

Additionally, you can appoint executors in your Will, assigning them the responsibility to manage and allocate your estate's assets.

It's also important to establish a Power of Attorney, permitting another person to make decisions on your behalf should you lose the capacity to make your own decisions.

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Estate planning solutions: A closer look

In this section, we cover off four widely used strategies for effective estate planning: Gifts, Trusts, Insurance and Business Relief (BR) Investments.

Each method has its unique advantages and potential drawbacks, it is important that you understand them fully before making any decisions. It is worth noting that this is not an exhaustive list of solutions available to you.

1. Gifts

Gifts involve transferring assets during your lifetime to beneficiaries, which can have immediate benefits and potential tax advantages.

There are allowances when it comes to gifting. Gifts between spouses and civil partners are IHT free. You are also awarded a yearly £3000 gifting allowance by HMRC. There are also wedding gift allowances of between £1,000 - £5,000 depending on who is receiving the gift.

Benefits

• Immediate access for beneficiaries: Gifting assets can immediately benefit the recipient, allowing them to utilise the gift during their lifetime.‍
• Potential IHT reduction: If you survive for seven years after making a gift, it's generally exempt from IHT.‍
• Flexibility: You can make numerous smaller gifts, use annual gift allowances, and gift on special occasions without incurring IHT.

Drawbacks

• Loss of control: Once gifted, you no longer have control over that asset.
• Potential for IHT: If you die within seven years of gifting, the gift might still be subject to IHT, albeit at a tapering rate.

2. Trusts

Trusts are legal arrangements where assets are held and managed by a trustee for the benefit of designated beneficiaries, offering control and protection.

Benefits

• Choice: A Trust structure allows you to specify how, when and to whom, assets are distributed. There are lots of different types of Trusts to suit your needs.‍
• Protection: Trusts can protect assets from claims, like those from creditors or during divorce proceedings.‍

Drawbacks

• Complexity: Setting up and managing a Trust can be complicated and may require legal and financial advice. There are many different types of Trusts that can be set up depending on how you want to control your assets.
• Costs: There might be costs associated with establishing and maintaining the Trust. If you transfer assets there is a 20% chargeable lifetime transfer tax on the assets valued over the NRB.
• Loss of access: Depending on who your beneficiary is, you could lose access to your capital.

3. Insurance

Insurance in estate planning typically involves life insurance policies that can offer immediate tax relief and financial security to beneficiaries.

Benefits

• Immediate IHT relief: Life insurance payouts can be structured to fall outside of the estate, providing immediate Inheritance Tax relief to beneficiaries.
• Potentially tax free income: Capital income (interest, dividends) made during the deferment period is added to the insurance contract and remains tax-free.

Drawbacks

• Age and health constraints: Older clients or those in poor health may face challenges in obtaining cover and passing the underwriting.
• Policy costs: The cost of premiums can be high, especially if the policy is taken out later in life or if the insured has health issues.

4. Business Relief (BR) Investments

BR Investments involve investing in qualifying businesses, offering potential for growth and rapid IHT exemption.

You can benefit from BR by; owning a trading business, investing in an estate planning solution with either unlisted share or AIM-listed shares or through an EIS.

With BR-qualifying investments, investors' shares become eligible for 100% inheritance tax relief after just two years, as long as the shares are held at the time of death. However, from April 2026 100% Business Relief will continue to apply to the first £1m of qualifying business and agricultural assets (in addition to the current nil rate band worth up to £500k per individual) and, there after, IHT will apply at half the normal rate, effectively reducing to 20%. This change will apply to unlisted inheritance tax solutions and private businesses that otherwise meet the Business Relief conditions. For Business Relief qualifying companies listed on AIM, IHT will apply at the halved rate of 20% (irrespective of the size of investment).

However, please note that  not all businesses qualify for BR but they have to be in a certain trade. https://www.gov.uk/business-relief-inheritance-tax/what-qualifies-for-business-relief

Benefits

• IHT relief after two years: BR-qualifying investments can become IHT exempt after just two years.
• Immediate IHT relief in certain circumstances: In some cases, IHT exemption can be immediate. This is typically when the investment is made with proceeds from the sale of a previously owned business or if the investor has taken out life cover that aligns with the BR investment.‍
• Growth potential: As investments, there's potential for capital appreciation.‍
• Access and control: Unlike some Trusts or gifts, you can usually access and/or sell your investment if needed.‍
• Individual Savings Accounts (ISAs): You could hold certain shares that qualify for Business Relief in an ISA. This means that you could potentially get the lifetime benefits of an ISA while also minimising your inheritance tax liability.

Drawbacks

• Loss of capital: As with any investment, there is always a possibility that the value of your investment can go down as well as up.‍
• Regulatory changes: The rules around BR could change, impacting the IHT benefits.
• Change in BR status: Changes in the business structure or operations can lead to a loss of BR eligibility of underlying companies. Regular reviews of the business’s qualifying status are essential.

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How do you know which estate planning solution is right for you?

Selecting the appropriate estate planning solution is crucial, but it can also be intricate. Several factors should be considered when deciding which tools or combination of tools best align with your circumstances.

Most importantly: Please speak to your financial adviser in order to decide which solution is right for you.

Evaluate your estate's size and composition

Before choosing solutions, assess the value of your estate and its individual parts. Do you primarily have liquid assets like cash or shares, or is your wealth tied up in properties, businesses, or other investments? The type and value of your assets will shape your planning strategy.

Determine your objectives: What are your primary goals for your estate?

• Are you aiming to maximise inheritance for your beneficiaries?
• Do you wish to provide for a spouse or partner after your passing?
• Are you planning to donate a portion of your estate to charity?
• Is tax efficiency your main objective?
• Is your estate valued above £2m? If so, you may not get all the reliefs available

By identifying your goals, you can align your planning solutions more effectively with your desired outcomes.

Consider potential beneficiaries

Your chosen beneficiaries may have differing degrees of financial freedom and financial expertise.

For instance, leaving assets to minor children might necessitate a different strategy than transferring assets to an adult child or a charitable organisation. Think about the age, financial literacy, and needs of those you aim to benefit.

Think about your time horizon

Some estate planning solutions, such as gifting, can take effect immediately, while others, like Trusts or BR-Qualifying investments, may be more or less suitable depending on the time horizons.

Weight the level of complexity

Some individuals prefer straightforward solutions, while others may be at ease with more intricate strategies that offer greater benefits or control. It's vital to opt for solutions that you comprehend and are comfortable with.

Risk tolerance

Every investment carries risks. If you're contemplating using BR-qualifying investments as a part of your estate planning, evaluate your risk tolerance to ensure it corresponds with your investment choices.

Seek professional advice

Consulting with financial and legal professionals is always advantageous. They can offer insights tailored to your situation, inform you about the latest tax laws and regulations, and guide you in making well-informed decisions.

Review regularly

Once you've opted for an estate planning solution, it's essential to revisit it periodically. Your financial status, objectives, tax laws, and family circumstances can evolve. By regularly reviewing your estate plan, you can ensure it continually aligns with your goals.

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Conclusion

In conclusion, deciding on the correct estate planning solution is a deeply personal process that varies for every individual. Reflect upon your circumstances, aspirations, and preferences, and seek expert guidance to craft a comprehensive plan that's tailored to your requirements.

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Opinions expressed represent the views of the author at the time of publication, are subject to change, and should not be interpreted as investment or tax advice.

Important notice: This article is for investment professionals only. This article is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. No reliance should be made on this content to inform any investment of tax planning decision.

This content contains information that is believed to be accurate at the time of publication but is subject to change without notice. The explanation of all of the tax rules set out have been written in accordance with our understanding of the law and interpretation of it at the time of publication.

Whilst care has been taken in compiling this content, no representation or warranty, express or implied, is made by Downing as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.