Inheritance Tax, often referred to as the “voluntary tax”, can have a significant impact on the wealth you pass down to your loved ones. With changes coming in April 2027, even more estates will fall within its reach. Labour’s autumn budget tightened reliefs and proposed taxing pensions as part of one’s estate, creating the perfect storm for IHT. In this mini-series, we aim to provide you with valuable insights and practical strategies to allow you to make informed decisions about inheritance tax (IHT) planning.
Welcome to our latest Insightful Planning with Astute video. Following the changes in Labour’s October budget (we did a video about that, which you can watch here), we have had lots of concerned client queries, specifically focused on the changes to inheritance tax. Not only do many of our clients who have inheritance tax planning in place now need this reassessing, but also many individuals who previously were assessed as having no liability to be mitigated now have a potential liability on death.
Changes to taxation rules happen often, and it is one of the key reasons that we have regular reviews with our clients, so you can be comfortable that your financial planner will address this with you. However, given that this so-called “voluntary tax” has been thrust into the spotlight, we thought it would be useful to talk about it here. Given that the inheritance tax regime and options available to mitigate it are far-reaching, we won’t try to squeeze everything into one video; instead, we’ve created this series.
In the tax year 2021/22, 4.39% of deaths resulted in an IHT charge. It’s key to remember that assets passed on between spouses or civil partners on death are exempt from inheritance tax, so many couples may only pay it once; however, both of their assets may have been impacted. For example, husband and wife John and Jane both have large estates worth £5million each. When John dies and passes his assets to Jane, there is no IHT to pay, but when Jane dies, there will be. Only Jane is included in the “4.39% of deaths” mentioned earlier, but in this instance, John’s assets were effectively taxed too, only he didn’t own them.
Before we get into it: if you have the benefit of working with Astute and this video raises any questions, then please don’t hesitate to get in touch with your Astute financial planner. If you are new to Astute and would like to get in touch, we have created a link (here) that will guide you to the right place.
Now, a sensible starting point for our series on this particularly complex area of Financial Planning is to introduce IHT; the tax rate, the allowances that you may have available, when it’s payable and the options available, which is the purpose of this video. Then in subsequent videos, we will go into more detail about the options available, their benefits and drawbacks and how they can be used to mitigate, or cover, any future liability to IHT.
To say that Inheritance Tax is only payable when you die is not strictly true, so instead let me say this: Inheritance Tax is due whenever you pass significant wealth to another individual or entity and is usually, but not always, triggered by death. Not much simpler, is it?
The main driver for IHT is the “transfer of wealth”, and the vast majority of the time, wealth is transferred on death. Whenever this happens, HMRC will want to take a cut; the headline rate of IHT is 40%.
Thankfully, we are each blessed with an allowance that we can use; the first £325,000 of our assets are not subject to IHT and taxed at a rate of nil – hence its name, the “nil-rate band”. Each individual is entitled to this allowance, and any unused allowance is transferable between spouses/civil partners. This means that a couple that is married or in a civil partnership can pass up to £650,000 to their beneficiaries free of IHT.
What do I mean by “unused allowance”? Well, whenever a person leaves assets to someone other than their spouse or civil partner, it uses up part (or all) of their nil-rate band. For example, John dies and leaves £100,000 to his son and the remaining assets to his wife, Jane. In this case, John would have used up £100,000 of his £325,000 allowance, meaning Jane can only claim the remaining £225,000 to be used against her estate when she dies (assets passed between spouses and civil partners are exempt from IHT and don’t use up the band). Jointly, they have still been able to leave behind £650,000 free of IHT, but the allowance has been used at different times, i.e. John has used £100,000, and Jane will use £550,000.
The nil rate band also comes into play when you consider lifetime gifting, i.e. giving your money away. I will go into more detail on this in the next video.
On top of the standard nil rate band, you may be entitled to the “Residence Nil-Rate Band” announced in 2015 and introduced in 2017, which, again, is an amount that can be passed on at a nil rate, but this allowance is specifically for use against your main residence. Each individual is entitled to a further allowance of up to £175,000 as long as they pass their main residence to a “direct descendant”. This allowance is capped at the value of the property, so, for example, if your home is only worth £100,000, then your Residence Nil Rate Band is capped at £100,000.
Again, this allowance is transferable between spouses or civil partners, meaning that a couple could have total IHT allowances of £1mn between them as long as they plan to leave their home to a direct descendant. Whilst on the subject, the term “direct descendant” is more encompassing than you would imagine; not only does this include bloodline relatives – children and grandchildren – but also the spouse/civil partner of those children or grandchildren, stepchildren, adopted children and foster children. It’s worth noting that siblings, nieces and nephews are not included in the definition, and neither is a Discretionary Trust, even if it is primarily for the benefit of a direct descendant. Don’t worry too much at this stage about what a Discretionary Trust is – you may have guessed that this will be covered in more detail later in the series.
Although the application of the Residence Nil Rate Band will be straightforward for the majority of people, overall, it is an extremely quirky piece of legislation that does not always behave in the way you would expect. For example, if a widow dies today, having lost their husband before the Residence Nil Rate Band was introduced back in 2017, their estate can still claim the husband’s allowance, even though it didn’t exist when he died. In addition, “downsizing relief” means that the allowance may not necessarily be capped at the current home’s value if the individual moved from a more expensive home within certain timescales; in these circumstances, they could use the old home’s value when establishing their entitlement to the allowance.
It’s a bit of a minefield, but because the quirks only come into play in relatively niche situations, I won’t cover them all here; all I can do is encourage you to seek advice if you are unsure of, or want clarity on your own position.
The Residence Nil Rate band is lost gradually if your estate exceeds a certain magnitude. For every £2 that your estate is over £2mn, the allowance is reduced by £1 until it is lost entirely. This means that there is an effective IHT rate of 60% for individuals on assets between £2mn and £2.35mn and for couples on assets between £2mn and £2.7mn. However, don’t worry about the nil-rate band of £325,000, that won’t be tapered away.
Let’s take a look at a quick example of this in practise. In scenario 1, John and Jane have a combined estate of £2.5mn, owned 50:50 exactly, including a home worth £500,000 that they are leaving to their children. John dies and leaves his £1.25mn to Jane; as his estate was less than £2mn, his Residence Nil Rate Band remains intact at £175,000. Jane subsequently passes away with an estate totalling £2.5mn. Ordinarily, she would be entitled to her own Residence Nil Rate Band as well as John’s, totalling £350,000, because her estate is over £2mn, her allowance starts to reduce. In this case, being £500,000 over the threshold reduced her allowance by £250,000, down to £100,000. Her total allowances are, therefore, £700,000.
In scenario 2, John and Jane are married and have an estate worth £2.5mn between them, but £2.2mn of this is in John’s name with the remaining £300,000 in Jane’s. As before, they still plan to leave their main residence to their children. John dies, leaving everything to Jane, but because his estate was £200,000 over £2mn, the Residence Nil Rate Band that Jane can claim is reduced by £100,000 to £75,000. Jane then passes away with an estate of £2.5mn; ordinarily, she would be entitled to her own Residence Allowance plus John’s unused allowance, so £175,000 plus £75,000 equals £250,000. However, because her estate is £500,000 over the £2mn threshold, this entire Residence Allowance is lost. As such, the eventual IHT liability is £740,000, even though the total asset values have not changed!
You can see that although John and Jane’s estate jointly totalled £2.5mn in both cases, their liability in scenario 2 is higher because of the way they owned their assets.
Now we have covered the basics of the regime: the tax rate and the allowances available, the next videos in our IHT series will delve into a variety of planning options that could help, which are: wills, gifting, trusts and business relief schemes.
When exploring these options, in typical Insightful Planning fashion, we will demonstrate how cashflow forecasting can be used to support your long-term IHT planning strategies so that you can tackle any issue you may have with confidence. It provides clarity, helping you strike the right balance between enjoying your wealth today and preserving it for future generations.
Whether you’re looking to make the most of your allowances, understand the implications of lifetime gifts, or explore advanced planning techniques, this series will guide you every step of the way.
When exploring these options, in typical Insightful Planning fashion, we will demonstrate how cashflow forecasting can be used to support your long-term IHT planning strategies so that you can tackle any issue you may have with confidence. It provides clarity, helping you strike the right balance between enjoying your wealth today and preserving it for future generations.
Whether you’re looking to make the most of your allowances, understand the implications of lifetime gifts, or explore advanced planning techniques, this series will guide you every step of the way.
