Nearly 10 per cent of deaths will be subject to inheritance tax (IHT) by 2018-19, up from 4.8 per cent in 2013-14, according to the Office for Budget Responsibility. Originally designed to only be levied on the very richest, a combination of rising house prices and successive governments’ failure to substantially lift the threshold at which it becomes payable has meant that ever increasing numbers of people are being caught out. IHT is deeply unpopular: not only is it a charge on lifelong prudence, but it is also a particularly heinous example of double taxation (as it is paid on money that has already been taxed).
The amounts due are by no means minor. It is levied at 40 per cent on estates worth over £325,000 (couples can combine their allowances, allowing them to leave £650,000, and assets can be passed between spouses or civil partners free of IHT). If you have a family home in the South East, it’s highly likely your estate will face IHT.
That’s unless you believe the Tories. They have promised to introduce a new IHT allowance worth £175,000 per person that, on top of existing allowances, would let a couple leave a primary residence worth £1m free of IHT. But this would not save everyone. As Fidelity’s Maike Currie says, the new allowance “would be tapered for estates worth more than £2m, with no extra relief for those valued at more than £2.35m.” And since it preferences those with expensive family homes, if you downsize and bank the cash, your heirs may still face a big bill.
So what can you do? Aside from essential steps like writing a will, you can limit your IHT exposure without complicated tax planning.
Recent reforms to pensions have created a compellingly simple way to prevent your heirs from paying excessive IHT on your estate. Last year, the chancellor announced the abolition of the 55 per cent “death tax” on pensions. This, says Tony Mudd of St James’s Place, makes the pension “almost the ultimate IHT planning vehicle.” Previously, tax rules incentivised people to spend their pension before they died, as whatever remained would face punitive charges. Now, your children can inherit the pension tax free.
But the benefits of the pension as an estate planning tool are much broader, says Mudd. You not only get tax relief on the way in, but you can also build a well-diversified portfolio of investments inside the wrapper which are broadly exempt from tax themselves. There is an added benefit. If you die after 75, your heirs will have to pay income tax on withdrawals. If you die before 75, however, “any money they take out will not be eligible for income tax at all,” says Mudd.
Most will not be able to go through retirement without touching their pensions. As David Goodfellow of Canaccord Genuity says, “the majority of people have to use it to provide themselves with an income.” But if “you have significant savings in other assets such as Isas and general investment accounts, it may be wise to use these and delay taking your pension,” says Currie.
OBR PROJECTIONS FOR DEATHS SUBJECT TO IHT UNDER CURRENT RULES
Proportion of deaths subject
to inheritance tax (per cent)
Number of deaths subject
to inheritance tax ('000s)
BUSINESS PROPERTY RELIEF
Business Property Relief (BPR) is a tax rule that allows you to leave qualifying assets to your heirs free of IHT, so long as your investment meets a set of criteria and you have held it for at least two years. In broad terms, it applies to investments in unlisted or private companies that do not themselves invest in stocks and shares or property. But as a measure of how odd the rules can be (it is not possible to be fully certain that an investment will qualify until you have died), some Aim shares are treated as unlisted.
Justin Waine is investment director at Puma Investments and runs its Aim IHT Portfolio Service, which selects Aim shares that qualify for BPR. You could, feasibly, buy Aim stocks via an investment platform yourself and try to select those that would qualify for BPR. But Waine says that the rules are so complex that this may be foolhardy: “if you’re not monitoring your investments every day, and a company decided to move from Aim and you miss it, it will sit in your portfolio, and when you die your heirs will discover that it’s not going to qualify.”
Waine admits that Aim stocks can be volatile, so it’s important to view them as a long-term investment. “Almost all IHT planning happens later than it should,” he says. But as Goodfellow points out, “there is a reasonably wide array of BPR allowable assets”. Aim stocks are at the higher risk end of the spectrum, but a number of other investment firms focus on renewable energy and infrastructure assets. Nevertheless, if you get the timing right, the IHT benefits of BPR mean that capital growth in the investment may not be so important. “If you invest £100,000 into a BPR portfolio, that’s going to save you £40,000 in IHT in any case,” Goodfellow adds.
GIVING IT AWAY
An important subtext to many estate planning vehicles (particularly the more unusual ones) is the threat of political risk. Although governments don’t tend to legislate retrospectively, “any type of planning is always going to be subject to change”, says Goodfellow. If you fear this, one option is simply to spend your money or give it away (a so-called living legacy). “Your last pound is what pays for your funeral,” he says. You must live for seven years after you have made a gift for it to be considered outside your estate and, once you have given away the money, you will have no control over how it is spent. There are, however, no limits to how much you can give.
If you want to be really forward-looking, the ultimate savings legacy for your children, says Currie, may well be the Junior Sipp. You can put £2,880 a year into this “baby pension”, which will be topped up by the government to reach £3,600. Even if you only put in one year’s full contribution at birth, this could grow to £127,500 by the time the child reaches 65 (assuming 5.5 per cent growth annually net of charges). Unlike the Junior Isa (you can contribute up to £4,080 into one of these in the current tax year), which can be accessed by the child at 18, the Junior Sipp cannot be touched until they reach 55, making it more suitable if you worry about irresponsible spending.
There are countless other IHT planning options available (bare trusts, to name but one). The one thing that catches many people out, says Karen Barrett of Unbiased, is timing. “The tricky thing is you almost need a crystal ball”. Speaking to an adviser early can really pay off.