Inheritance tax can leave your loved ones with an unnecessarily large bill. In fact, the 2022/23 tax year was record-breaking for HMRC as it earned a staggering £7.1bn in inheritance tax receipts – a 16% increase from the year before. But there are several ways to legally save a substantial amount on your estate.
Below, we go into the details of inheritance tax to outline how it works, any upcoming changes to the regulations that you should be aware of, and how to utilise tax-efficient vehicles and strategies to protect your estate and your family.
Inheritance tax rules 2023/24
The tax-free allowance for the 2023/24 tax year is £325,000 per person (£650,000 per couple). This allowance can increase depending on who you leave your home to. If your estate is inherited by your children or grandchildren, they could receive an additional allowance of £175,000 on top of the £325,000, so inheritance tax may not be due on the first £500,000 of your estate. This is known as the main residence band and it applies if your main residence is passed onto your biological, adopted, foster, or stepchildren or grandchildren. However, the following caveats apply:
· Your estate must be worth less than £2m to qualify for the nil rate band.
· If your estate is worth over £2m, the nil rate band decreases by £1 for every £2 above £2m of the estate’s value.
· If your estate is in a discretionary will trust, it will not qualify for the nil rate band even if the beneficiaries of the trust are your children or grandchildren.
To put the above numbers into perspective, let’s say your estate is worth £525,000 and you’re leaving it for your children to inherit. No inheritance tax is due on the first £500,000, and the remaining £25,000 will be taxed at 40%. That’s a total of £10,000 in tax. If your children are not the beneficiaries, there is no tax due on the first £350,000 and 40% tax applies to the remaining £200,000, which is a total of £80,000 in inheritance tax.
The rules are also slightly different for married couples. If your estate is inherited by your spouse or registered civil partner, it is exempt from inheritance tax. Also, any of your unused allowance is added to your partner’s allowance (including the nil rate band allowance), so a couple can currently be entitled to £1m tax-free (2 x £325,000 + 2 x £175,000).
Proposed changes to inheritance tax
For the 2023/24 tax year, the inheritance tax allowance is frozen at £325,000 until 2028. The main residence band of £175,000 is also frozen until then, but some rules around inheritance tax and Capital Gains Tax (CGT) have been introduced.
The 2019 inheritance tax report stated that businesses and farms are exempt from inheritance tax and, effectively, CGT. This means that when a business or farm is inherited, its profits are passed over as inheritance rather than taxable gains. For example, if you leave £300,000 worth of assets, its beneficiary will inherit the full amount and would not be liable to pay CGT if the assets were to be sold for the same price. However, if the recipient sells at a later date for a higher value, let’s say £350,000, CGT will apply after deducting the annual allowance of £12,300.
Below are the proposed new rules for CGT (£3,000 allowance) on the immediate part sale of inherited assets worth more than the inheritance tax allowance:
|Current rules||Proposed new rules|
|Inherited asset value||£1,000,000||£1,000,000|
|Inheritance tax allowance||£325,000||£325,000|
|Inheritance tax payable||£270,000||£270,000|
|Assets needed to be sold to pay IHT for higher rate taxpayers||£270,000||£336,000|
|Assets needed to be sold to pay IHT for additional rate tax payers||£270,000||£346,000|
|Remaining assets for higher rate taxpayer||£730,000||£665,575|
|Remaining assets for additional rate taxpayer||£730,000||£655,185|
The above example shows part of the inheritance sold and part kept in assets. If the recipient sold the full inheritance: the below proposed new rules would apply from 2024:
|Current rules for all taxpayers||Proposed new rules for higher rate taxpayers||Proposed new rules for additional rate taxpayers|
|Amount on which CGT is charged||£0||£497,000||£497,000|
|Net gain from IHT after £270k paid||£730,000||£531,200||£506,350|
Although inheritance tax rates avoided any changes in the current tax year, the proposed new rules for CGT could impact the beneficiaries of your assets. Also, more changes may be on the way in future budgets that could have significant effects on your investments, so it’s important to protect yourself and your loved ones.
How to protect your wealth
For effective estate planning, it’s crucial to understand and keep up to date with tax laws and regulations, which can differ in each country. In the UK, inheritance tax rules are different for residents and non-UK domicile individuals, and the nil rate band is transferable, meaning that your spouse or civil partner can add any of your unused allowances to theirs, which minimises the tax bill.
Here are a few tax-efficient strategies that can protect your assets and your loved ones from a substantial inheritance tax bill:
Once way to reduce your inheritance tax liability is through gifting. For example, you could help your children or grandchildren build a nest egg for their early adult life with a JISA (Junior ISA), which offers an annual allowance of £9,000 for under 18s.
You may also find a JSIPP (Junior Self-Invested Personal Pension) useful if you’re looking to support the younger generations with their retirement income. You can contribute up to £2,880 a year into a JSIPP and the government’s contribution is tax-free.
For your loved ones aged 18-39, you could consider a LISA (Lifetime ISA), which can relieve your tax implications whilst helping them get on the property ladder. The annual LISA limit is £4,000 and the government contributes 25%, making the maximum contributions £5,000 per tax year.
EIS and SEIS
|EIS tax advantages||SEIS tax advantages|
|Up to 30% income tax relief on investments up to £1m.||Up to 50% income tax relief on investments up to £200,000.|
|CGT exemption on the sale of shares if the investment is held for at least 3 years.||CGT exemption on the sale of shares if the investment is held for at least 3 years.|
|CGT can be deferred if profits are re-invested in EIS-qualifying shares.||CGT can be halved if profits are re-invested in SEIS-qualifying shares.|
|Shares can be passed on IHT-free.||Shares can be passed on IHT-free.|
The pension and money purchase allowance has increased this year to £60,000 and £10,000 respectively, and the lifetime pension charge has been removed. Taking advantage of your full pension allowances each year can minimise the tax on your estate and, depending on your type of scheme, pensions can also be used to transfer wealth.
Pension pots are not subject to inheritance tax when you die. If you die before the age of 75, the person(s) that inherit your pension pot can draw on the money as they wish without paying any income tax either.
If you own a business or business shares for at least two years, business relief can offer either 50% or 100% inheritance tax relief on your business assets anywhere in the world. This tax break applies if the assets are passed during your lifetime or as part of your will.
Placing your assets in a trust can be a useful way of reducing your inheritance tax bill as the value of those assets are not counted towards your total estate. As well as offering IHT benefits, trusts can also be a good way of controlling and protecting your asset for the beneficiary.
Charity donations can help reduce your IHT bill while supporting a valuable cause. You can also claim tax relief for charitable donations such as Gift Aid or Payroll Giving.
Seek professional advice
Estate planning and tax can be complex depending on the value of your assets and your beneficiaries. It’s wise to work with financial professionals who specialise in UK tax and estate laws and can navigate your personal circumstances and tailor your needs to current regulations. Alongside this, it’s important to review and update your estate plan regularly to make sure any personal changes or new tax laws continue to align with your objectives.
Maximise your returns
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