Lifetime IHT Planning - 3 Easy Wins
By Mark McLaughlin
Mark McLaughlin points out that inheritance tax planning need not be complicated to achieve significant potential savings.
Death is a difficult subject to discuss - especially one’s own death! This is probably a reason why inheritance tax (IHT) does not always get the attention it deserves from those individuals potentially affected by it (and it should be remembered that IHT charges can arise during lifetime as well as on death, such as upon making gifts to most types of trust, subject to any IHT reliefs and exemptions available).
Some individuals seem to assume that lifetime IHT planning must be complicated. However, this is not necessarily the case. Significant IHT savings are possible simply by making regular use of available reliefs and exemptions. For example, this article briefly outlines what can be achieved through a combination of three elements:
- Annual exemption - Transfers of value (e.g. gifts) are generally exempt from IHT up to a maximum of £3,000 per tax year. Any unused annual exemption can be carried forward to the following tax year (but not beyond) (IHTA 1984, s 19);
- Nil rate band - Every individual is entitled to an IHT threshold (or ‘nil rate band’). Where chargeable lifetime gifts (and the individual’s death estate) do not exceed the nil rate band (£325,000 for 2015/16), there is no IHT liability;
- Seven-year accumulation - Most types of lifetime gifts (e.g. from one individual to another) are potentially exempt transfers (PETs). A PET made more than seven years before death becomes an exempt transfer. Conversely, a PET becomes a chargeable transfer for IHT purposes if made within seven years of death (IHTA 1984, s 3A). Chargeable transfers within the seven-year period ending with the latest chargeable transfer are cumulated, for the purpose of determining the IHT rate (IHTA 1984, s 7) (although if the individual made a PET within seven years before death, which therefore becomes chargeable, it may be necessary to take into account chargeable transfers within the seven years before that, making up to 14 years in total).
The IHT savings may be doubled if married couples (or civil partners) make use of these elements, and substantial combined IHT savings can be achieved over a relatively short period of time.
Example – Regular lifetime gifts
John and Sarah are both aged in their mid-60s. They built up a large portfolio of investment properties over a 25-year period, and sold them recently for a substantial sum. John and Sarah would like to start passing some of the post-tax proceeds to their adult children, but wish to keep their tax affairs and IHT planning as simple as possible. No previous lifetime gifts have been made.
They each decided to make cash gifts of £331,000 on 1 April 2015 (i.e. an amount equal to their IHT annual exemptions for 2014/15 and unused amount for 2013/14 (£6,000 in total), plus their nil rate band of £325,000). In 2015/16 and the following five tax years up to 2020/21, they each decide to make cash gifts of £18,000 in total (i.e. the annual exemption each year for six years). On 6 April 2022, John and Sarah will repeat their original gifts of £331,000 each (i.e. their annual exemptions for 2022/23 and unused amount for 2021/22, plus their nil rate band) (for the purpose of this example, it is assumed that the annual exemption and nil rate band remain unchanged).
In the above example, in a little over seven years John and Sarah will have each managed to reduce their estates by £680,000 (i.e. £331,000 plus £18,000 plus £331,000), or £1,360,000 between them; a potential IHT saving at the 40% ‘death rate’ of £544,000.
For some, this strategy may seem rather obvious; yet in my experience, it is seldom seen in practice.
Other IHT reliefs and exemptions (e.g. normal expenditure out of income) could also be considered, as appropriate. Where assets are being given away instead of cash, other taxes (e.g. capital gains tax) may need to be addressed. Above all, IHT (and other tax) mitigation should never take precedence over personal circumstances and financial needs.
Published March 2016