AHEAD of the general election, there was plenty of chatter about the Conservatives’ pledge to raise the inheritance tax (IHT) threshold to £1m. But the importance of appeasing the Liberal Democrats has superseded the need to appeal to the Tory heartland. The threshold is expected to remain at £325,000 for an individual and £650,000 for a married couple when George Osborne presents the emergency Budget next Tuesday. Anything above this amount is taxed at 40 per cent.
With the nil-rate band (as the threshold is known) staying where it is for the foreseeable future, it has become even more important to plan for what happens to your estate after you die. You should start with writing a will, of course, but through careful financial planning you can reduce the value of your estate that is liable for inheritance tax by either making gifts or investing in assets that qualify for IHT relief.
If you want to just give your money away then you have several options available. First, you can give away £3,000 free of tax every year to whomever you like. And if somebody you know gets married, then you are allowed to give them £5,000 completely tax-free as a wedding gift.
Unfortunately, if you have a substantial income, these kinds of sums are only going to be a drop in the ocean. But fewer people are aware of the normal and reasonable expenditure rule. “This essentially means that you can give away amounts on a regular basis that will be immediately exempt from IHT provided that it doesn't reduce your standard of living and generally comes out of your private bank account,” says Tony Mudd, head of tax at St. James’s Place, a wealth management firm.
You could enter into a gift and loan arrangement, where you set up a trust with a small gift and then lend the trustees a large amount. Every year, they will repay some of the loan, providing a regular source of income but the IHT liability is zero.
However, Piers Master at Charles Russell points out that you can also pay inheritance tax during your lifetime. “Certain gifts to trusts and companies can incur a special rate of 20 per cent immediately. If you die within seven years, it could be topped up to the full amount,” he explains.
If you want to retain control over your money but would still like to mitigate the potential impact of inheritance tax on your estate, then there are certain investments that are worth considering.
Business property relief is the most popular for this purpose. This legislation means that shares in unquoted companies (including those that are Aim-listed) qualify for IHT exemption. You only have to hold these assets for two years before they become IHT-free, which makes them popular with elderly investors.
Therefore, investing in an Aim portfolio can be a good idea if you are looking to mitigate IHT. “These portfolios have to make sense regardless of the tax benefit,” says Richard Hallett, a fund manager at Hargreave Hale, which specialises in small-cap investing. He adds: “We invest in companies which have been through business cycles, that generate cash to grow, that don’t make acquisitions and that pay dividends. We try to pick the better quality, more institutionalised smaller companies. But importantly, they must be liquid – the average market capitalisation for most of our portfolios is well over £100m.”
Forestry investments also have tax benefits, besides business property relief, says Jonathan Gain at Stellar Asset Management, which runs two forestry funds. He explains: “There is no tax payable on the value of the timber that you chop down and it is also free of capital gains tax.”
Besides the various IHT exemptions, it is also worth bearing in mind the niceties of inheritance tax regulations. Phil Smith, head of financial planning at Barclays Wealth, points out that you could consider adding to your pension fund. This can amount to quite a large sum and, if you haven’t started withdrawing, then any money passes tax-free to your dependents.
Equally important to note, particularly if you have elderly relatives, is the deed of variation, which allows you to restructure a will for tax purposes within two years of death. Smith says that Barclays Wealth see a lot of people doing this because they don’t want to increase the value of their own estate and would rather pass it onto somebody else.
Death and taxes are both certain in this world, but at least you can reduce the impact of one of them.