Inheritance Tax: why it pays to start early
Phil Jenkins, a Chartered Financial Planner with Wren Sterling, discusses changes in Inheritance Tax (IHT) and sets out a basic checklist for clients. More of us will need to consider IHT planning in the future. This is illustrated in an article published in the Telegraph, in which the Office of Budgetary Responsibility predicted that 10% of estates will be subject to IHT in 2018/19, up from 5% just five years earlier.
Money Matters: Hi Phil, there’s been a lot about IHT in the media in recent years, so probably a good time to catch up on what’s changed and what people need to consider when arranging their affairs for IHT.
Phil Jenkins: It’s true – IHT has seen significant change, like the £1m IHT threshold and the freezing of the £325,000 nil rate band until 2021. What’s more, property has been generally increasing in value in recent years, particularly in the South East and London, so it’s pushing more people into IHT territory than before because property tends to be their main asset. So much so that in an article in the Telegraph, the Office of Budgetary Responsibility estimated that a third of all Wills may have to be rewritten if clients want to benefit from the new £1 million joint allowance, due to be phased in between now and 2021. To benefit from this new allowance, the home has to pass to a child or grandchild, so if the house does not go straight to the children, the homeowner’s beneficiaries will not get the allowance.
Interestingly, the £1 million allowance does not apply to assets outside of the family home.
MM: So plenty for people to get up to speed with. When do you think people should start thinking about IHT and what’s the reality in your experience?
PJ: Typically, clients have retired when they begin to plan IHT. I think clients should start to consider this at the point where they have built their asset base and have sufficient income to sustain the standard of living they’re looking to achieve. For some clients, this may be when they’re still in work. In some cases, leaving it until retirement will be too late, especially for people who are cohabiting but not married. Where an unmarried partner inherits assets, IHT may be payable, which will be complicated further if there is no Will.
Leaving IHT planning to later in life also raises the possibility of being taxed on gifts already made as they’re more likely to die within the seven year timeframe for tax-free gifting. It’s definitely the case that understanding the rules around this earlier can inform clients’ decisions.
MM: Right, so it’s one of those things that people should think about earlier than they do – sounds a lot like financial planning. For those people that haven’t started, what are the basic elements they need to consider?
PJ: First, IHT has to be paid. Under the current rules, changing a Will to reduce an IHT bill is classed as tax avoidance. However, there are efficiencies that can be made and strategies for reducing tax. There are generally three estate planning strategies widely used by advisers. Clients can:
- Make ‘lifetime gifts’
- Insure against the tax liability through life assurance held in trust – so a policy that pays the value of the tax bill upon death
- Invest capital or move existing investments into qualifying investments, for example investments that qualify for Business Property Relief
MM: You mentioned cohabiting couples not getting the same rights as married couples. Aside from tying the knot, what can they do to make sure they are not liable for a large tax bill on the death of the first person?
PJ: This depends on how you are structured legally and the permutations are quite different. What you pay will depend on how you owned any shares or property or how your bank accounts were set up. Let’s look at property in this scenario.
Typically, couples own their home as joint tenants. This means that both own the whole of the home. With tenants in common each owns a set share – this can either be half each, or a defined percentage. If you own your home as joint tenants, then if one partner dies, the other automatically becomes the sole owner of the home.
With tenants in common one member of a couple can pass on their share of the home on death, say to their children, while the other member of the couple can continue to live there, passing on their half on death.
Tenants in common can also prevent you having to sell your home if you need to go into long-term care. It is also a way for couples who have put unequal deposits into a property to protect their share in case they split up. This can ease the fears of families gifting deposits to their children.
For example, the property can be held as tenants in common, with a document showing one owner put in 70% of the deposit and one owner 30% and in the event of break-up and sale the initial deposits should be returned as such.
MM: So plans will need to be regularly revisited to make sure they’re appropriate?
PJ: That’s right. The phased aspect of these changes means plans made recently may not apply in 2018/19, so clients should make sure they inform advisers of changes in their circumstances, for example, if they downsize their main residence so it is worth less.
MM: It sounds like the bigger picture really needs to be considered here, this isn’t justabout making gifts in isolation or writing a Will is it?
PJ: Absolutely not. As with any aspect of financial planning, there are consequences to almost every action which only an expert will be able to see. I recommend that clients speak to their advisers about IHT and consider the following as a starting point:
Top inheritance tax tips
- Make sure you’ve written a Will and it is up to date
- Arrange the property ownership on the correct basis – i.e. how you would like it to be structured for inheritance purposes
- Use exemptions – i.e. the £3k a year gifting allowance
- Look at gifting strategies that include making gifts out of surplus income, plus outright gifts classed as Potential Exempt Transfers
- Consider arranging insurance to allow your beneficiaries the resource to be able to pay Inheritance Tax