Death and taxes, or as Roy Jenkins once said, “it is a voluntary levy, paid by those who distrust their heirs more than they dislike the Inland Revenue”. To those paying the taxman the 40% due it certainly doesn’t feel like a voluntary levy, and in some cases, it is in fact unavoidable.
As we write this article, the Conservatives have floated the idea of abolishing IHT altogether, or at least have it in their manifesto for next year’s general election. We must be cognisant that few manifesto pledges seem to be enacted, but it is deemed to be a cheaper “give-away” pre-election, than a 2p income tax cut. We do hear of give-aways just before a general election, almost as if these sway the voting public. At the same time, we see articles regarding the possibility of the removal of tax-free death benefits. The two appear at odds with each other.
Leaving these rumours to swirl, we will focus on where we are at present.
HMRC introduced an additional Residence Nil Rate Band (RNRB) of £175,000 some years back, to be added to the standard Nil Rate Band (NRB) of £325,000 for Inheritance Tax, but the freezing of the latter combined with the increase in house prices, has ensured that the tax man is taking in more and more of this “voluntary levy”. Another favoured term for Inheritance Tax is “wealth distribution”, but many will argue that they are not seeing the benefit of this distribution., whereas one of our national press recently called the tax a “legalised theft” and are calling for it to be abolished.
Other presses have been less sensational and advise readers to take action and/or seek advice to avoid or reduce this tax.
Let’s start with the basics. IHT is payable at 40p in the £1 on the value of the estate above the applicable thresholds (Nil Rate Band(NRB) and Residence IHT Nil Rate Band (RNRB)). For most this is £500,000 for an individual or £1m for a couple. That is some achievement, becoming a higher rate taxpayer upon death!
It can’t have escaped many that these thresholds have been frozen by the Government for several years now and will be till at least 2026, thus more estates have fallen and will continue to fall into the bracket of tax becoming due. The Office of National Statistics regularly publishes these figures, both on tax taken and the number of estates.
The below illustrates the effect of the freezing of the “allowances” whilst properties and other wealth have increased.
Inheritance Tax Receipts:
Source: Statista.com May 2023
Receipts for 2023/24 are expected to exceed £7.7bn, and HMRC have also just announced their largest 3 monthly take of £2bn for the first 3 months of the current tax year.
The first recommendation should almost always be to create a will, and have it completed! There have been cases where wills have been written, but for whatever reason they remained incomplete – not signed by witnesses as “they never got around to it” is a recent example.
If someone dies without a will the estate will follow the route of intestacy. This should be avoided as it ignores any wants or needs. I suggest all clients without a will being recommended to complete the following, really useful, exercise on the government website.
Intestacy - who inherits if someone dies without a will? - GOV.UK (www.gov.uk)
Please do familiarise yourselves with the nuances by going through it also.
All clients should at that point be convinced to make a will. These need not cost a fortune and serve multiple purposes.
Firstly, what a great opportunity to create a contact list of professional connections. Demonstrating to solicitors that you want clients to have all legals in place and will only advise them once you receive those referred clients back. It would also be an ideal time to complete a Lasting Power of Attorney, again a subject in its own right which we will return to in a future blog.
Secondly, clients will be reassured by that third party that what you are offering and subsequently recommending is not your priority, by ensuring the legal situation is more important, plus the fact that they will validate your services.
Thirdly, when done well, the referrals to the solicitors could start a proper two-way relationship as they will certainly see people for wills and not know where to refer. Solicitors have to follow a strict set of rules, and one of these, rule 3.1 states:
“You only act for clients on instructions from the client, or from someone properly authorised to provide instructions on their behalf. If you have reason to suspect that the instructions do not represent your client's wishes, you do not act unless you have satisfied yourself that they do. However, in circumstances where you have legal authority to act notwithstanding that it is not possible to obtain or ascertain the instructions of your client, then you are subject to the overriding obligation to protect your client's best interests.”
In other words, solicitors take instructions and do not give financial advice and should thus refer clients to you to protect their clients’ best interests. Letting clients walk out of their practice, knowing they need you/your advice would breach this duty of care.
Without a will, IHT planning should not be started. Our recommendation would be to review all wills every two years, as assets and circumstances change regularly. One of the legal quirks in England & Wales (not Scotland or Northern Ireland) is that the act of marriage legally revokes any pre-existing will. Also relevant here is knowing that the act of legal divorce does not revoke an existing will. This means that until new wills are written upon remarriage, estates fall back to the laws of intestacy. It is so important to revisit wills when individuals get remarried or divorced.
Looking next at assets many of us own, our largest assets are usually property and pensions, but few remember to look at how we own our property(ies). It would thus be remiss were we not to include property ownership as part of IHT planning, Property can be owned as Joint Tenants (all parties own all of the property and the law of survivorship applies), or Tenancy in Common where the property ownership is split, and each party can leave their part in their will. I will cover these in far more detail covering the advantages and disadvantages of each, both for main residence and subsequent properties in a subsequent blog/article. It is often simpler to gift away a second or subsequent property as these are not usually the main residence for a surviving spouse, so no “life tenancy” will be created.
Suffice to say that ownership needs to be considered before and at the time of writing a will and thus am including it for estate planning purposes.
The current Nil Rate Band stands at £325,000 per individual, with an additional £175,000 in the Residence Nil Rate Band. Any unused Nil Rate Band can be transferred to a spouse or civil partner, see the form attached here.
Under the rules of the RNRB, you must pass your home to a direct descendant to receive the allowance, either a child or grandchild, with neither nieces, nephews nor friends qualifying.
Not everyone will qualify for the full allowance. If your total estate is worth more than £2m, the extra allowance tapers off, falling by £1 for each £2 above the threshold.
Similar to the standard NRB, the RNRB is transferable between spouses, applying any unused allowances, thus ensuring up to £350,000 worth of property can be passed on to the direct descendants tax free in 2023/24.
See: Transferring unused residence nil rate band for Inheritance Tax - GOV.UK (www.gov.uk)
After property, and even sometimes before property, a pension can be a large asset to consider.
Pensions Freedom introduced another fresh tax-planning vehicle in that since that was introduced certain pension vehicles are now inheritable. Again, a perfect reason for reviewing and planning, especially with the removal of the Lifetime Allowance (with the exception of the Commencement Lump Sum). Please remember though that the tax tail should not wag the investment/planning dog.
A recent survey on pensions drawdown v. annuities illustrated a disconnect between what advisers thought their clients preferred, compared to what those clients themselves answered direct to the same survey. This will always be a delicate balancing act, especially when annuity rates have risen significantly since 2016, although they have plateaued over the last year. The decision to annuitise is however irreversible so requires some thought. Should clients now also consider part annuity/part drawdown (certainty plus flexibility)? Again, this would indicate an increase in the need for clients in that age bracket to be contacted by advisers.
Nevertheless, a very useful planning tool was created through the change in pension legislation. The number of clients looking to use this to pass on wealth, sometimes at the expense of their own luxury in retirement, is certainly on the increase.
Having ensured the clients have completed their wills and LPAs, looked at their property ownership and pensions, they can now put their desire to cover the IHT liability in the mix with all their other financial planning needs. Once decided that IHT is to be addressed, the different solutions can be offered for consideration depending on whether they allocate income or capital, or a combination of both.
One of the most common overlooked areas with regards to IHT exemptions is the “Normal Expenditure Rule”. Clients can give away all their surplus income, as long as it is income – earned and unearned income, pensions, dividends, interest, but not the 5% withdrawals permitted from investment bonds (as that is deemed a return of capital). HMRC will permit these payments to be fluctuating in amounts and regularity as long as these are documented. It must be done at least every year, or at a stretch every other year, after which it is deemed that the income accumulated has become capital and thus falls under the gifting from capital rules (Potential Exempt Transfers).
Use of income to pay the premiums on a whole of life insurance policy, in trust, where the sum assured pays out to the beneficiaries to pay the IHT bill could also be a consideration. There are of course several important aspects to consider; insurability (these clients are usually older and with that can come adverse medical conditions), and affordability (especially if premiums increase annually). These policies must always be written into trust. If not, all that has been achieved is an increase to the estate by the value of the sum assured, leading to an increase of 40% of that as an additional tax levy. Additionally, by not having written the policy into trust any potential beneficiaries need to wait for probate, or Confirmation if in Scotland, to be granted before they can receive access to the estate. The average time for this process is around 9 months.
See: https://ukcareguide.co.uk/how-long-does-probate-take/
At this point I always look to professional connections again. Life office trusts are adequate but a properly drafted trust taking proper care of the beneficiaries at different life stages is always so much more professional. I have yet to see a life office trust that will pay out some monies at 18, some for university fees, some again at attaining 25, marriage, or upon the birth of a grandchild if sooner, for the deposit on a property, and final disbursement at 40. This is of course just an example but trustees handing all over to the beneficiaries attaining the age of 18 does not sit well in many circumstances. I can’t see any client being lost to advisers by doing this well, and the leads from then speaking to trustees thereafter must also be beneficial. We do after all tend to mix with similar people to ourselves so this should introduce similar clients to the adviser firm.
Then consider capital. Where clients can afford to, they can gift away capital. We have exempt transfers and potentially exempt transfers at our disposal for this. Whatever method of gifting is considered, these must always be carefully documented, and even more importantly be to hand if ever challenged by HMRC.
Covering exempt transfers first, there are not many, nor have there been any increases in these for many years.
Transfers between spouses are exempt but do little, if anything, to reduce the estate. The other exempt transfers from capital include a £3,000 annual exempt amount per donor (and the use of a previous year if unused), a small gift allowance of £250 to any number of people, gifts in consideration of marriage (£5,000 from a parent, £2,500 from a grandparent, and £1,000 for anyone else), charitable gifts and unsurprisingly gifts to political parties. The last has no limits on amounts but does have restrictions on the receiving political recipients, suffice to say that only larger parties are able to benefit from such donations.
Once the exempt gifts have been exhausted, we can consider potentially exempt transfers. Called so, because if clients survive 7 full calendar years from the date of the gift, the word “potentially” falls away and they become exempt. Should death occur within 7 years of the gift however, the gift is not exempt and will become taxable. It must be emphasised that gifts must be made absolute/unconditional, with no strings attached. This includes gifts into trust, so leaving a life tenant will leave the tax burden on their estate. Care must also be taken if placing gifts into a trust as the beneficiaries can force the trustees of the trust to pay out if all the beneficiaries are known, no more can enter the class of beneficiaries and all beneficiaries agree. There are ways to protect against “greedy” or spendthrift beneficiaries, discretionary trusts or through the creation of a trust with the potential of further beneficiaries to be added (future children/remoter issue). Again, as said previously, trusts will merit its own article.
A word of caution when leaving a gift in a will. Please always create certainty. If a percentage is left, then a beneficiary could contest the estate to increase its value (to then receive more). This also came up recently with a farmer leaving a percentage to a charity and that charity contesting the estate valuation, arguing that with planning and building consent the land would be worth many multiples of the then current valuation. The estate took some years to be settled and the only real winners were the solicitors acting for the parties.
If considering from what pot of capital to gift, one should not overlook Cash ISAs. This may sound strange, but Cash ISA’s are in fact subject to IHT. They are Income Tax and Capital Gains Tax free, but not IHT. As at 2020, some £300bn+ was sitting in Cash ISA’s (Source: Commentary for Annual savings statistics: June 2021 - GOV.UK (www.gov.uk) as can be seen below. Just how much of this sits with the more mature clients whose estates will be subject to IHT is not certain, suffice to say that it is mainly these clients that hold the larger Cash ISA pots.
Even a small fraction of £300bn at 40% will contribute a sizeable chunk to HMRC’s coffers. It might be worth reviewing to see if these clients can be better served with alternative products. Let me finish on a cautionary note on this though, never let the tax tail wag the investment dog! At the beginning of the article, I mentioned that IHT could even disappear. If that is the case a client could be disadvantaged by having been taken out of the ISA as going back in has annual contribution limitations.
The same can be said with regards to Equity ISAs, although some will be in AIM share portfolios so IHT exempt after 2 years. For those equity ISAs not however, it is again weighing up tax free dividends and growth versus IHT.
More rules come into force when gifting capital or assets, as there will be a sliding scale applied to gifts in excess of the nil rate band. Any gift in excess of £325,000 (currently) will benefit from a reduction after 3 years of survivorship. Most will note immediately that this “generous” tapering relief affect only the very rich who can gift away sums in excess of £325,000, but there will be instances whereby parents gift away a second or third property to their children, thus the reliefs apply here (as well as potential CGT on the disposal by the parents).
Regardless of where the capital is held by the client, the questions remain regarding the need for access to the capital and/or the income this is providing. Another pivotal issue is the health of a client, as someone with limited life expectancy has fewer options available to them to look to either reduce or plan to remove the IHT liability. The shorter the term the higher the risk of the vehicle available for use, with AIM and unquoted companies being utilised as they attract Business Relief on shares and thus fall outside the estate after two years of ownership.
For more mainstream solutions it is back to access:
Just to complete this article, remember that all gifts should be documented fully. This article covers IHT and as such the donor will not be around to explain their actions. It will be their estate administrators and executors who will end up completing the forms for IHT. I have placed the link to the main form below, and within this form are embedded links to all other needed for bank accounts, share holdings etc. Again’ knowing your way around these forms when a client needs your assistance speaks volumes and is great for retaining the family as clients.
Inheritance Tax account (IHT400) - GOV.UK (www.gov.uk)
As always, we are always grateful of any feedback, positive and developmental so that we can improve our services and materials for you.
