People are often slightly in the dark when it comes to which assets are liable for inclusion in estates for Inheritance Tax (IHT) purposes; there are important distinctions to remember which might make a significant difference to your plans.
More and more families are finding themselves facing IHT bills when their loved ones sadly pass. Since this hefty 40% levy on assets over the relevant threshold has to be paid before the assets in an estate can be distributed to beneficiaries, families will often need to sell assets or take out a bank loan to settle their account with HMRC before they can proceed with administering the estate.
First, a recap of the thresholds for IHT. The nil-rate band is £325,000 for individuals and £650,000 for married couples or civil partners. Since 2017, there has been an additional nil-rate band if a residence is passed on to a direct descendant. This “main residence nil-band” of £175,000 could potentially increase the overall allowance to £500,000 for individuals and £1m for couples.
IHT is often called the “voluntary tax”. In order to formulate a plan to mitigate IHT you must first understand which assets are and which are not counted as part of your estate for IHT purposes (as opposed to distribution)
These are large figures at face value, but perhaps not so much when decades of house price growth and the accumulation of wealth over generations are taken into consideration. Little wonder that IHT receipts have soared in recent years and are forecast to continue to do so as more and more even modestly wealthy individuals fall into the IHT net.
IHT is often called the “voluntary tax”. In order to formulate a plan to mitigate IHT you must first understand which assets are and which are not counted as part of your estate for IHT purposes (as opposed to distribution). Then, you and an adviser can look at the myriad ways that IHT can be mitigated for the assets open to IHT.
Property which is included in the estate for IHT purposes
For IHT purposes, the deceased’s estate is any asset to which they were beneficially entitled to upon death. This will of course include anything that they were entitled to distribute under their will or the rules of intestacy, but there are some further nuances to understand about what can get caught in the IHT net.
- Property subject to a reservation: An easy trap to fall into is to give away an asset (like a house) but retain the use of it and so leave it open to IHT at market value on death. Such assets must really be given away and perhaps rented back – and the donor survive seven years – in order to remove the IHT liability.
- Jointly-owned property: Although property like a joint bank account or house which is owned under joint tenancy will pass to under survivorship rules rather than a will or intestacy, these assets are included in the estate for IHT purposes.
Although property like a joint bank account or house which is owned under joint tenancy will pass to under survivorship rules rather than a will or intestacy, these assets are
included in the estate for IHT purposes
- Nominated property: Friendly society or National Savings & Investment Accounts may be set up to pass directly to a named individual with only proof of death needing to be shown, but again these assets are included in the estate for IHT purposes.
- Lifetime gifts conditional on death: Due to their conditional nature (i.e., activating upon death), these gifts are included in the estate for IHT purposes.
- Interest in possession trusts: These are trusts where the trustees must pass all trust income to the beneficiaries as it arises. For IHT purposes, the deceased is treated as having owned the capital and it is taxed as such as part of their estate.
Top Tip
Lee Goggin
Co-Founder
Property which is not included in the estate for IHT purposes
On the flipside, property which is not included the deceased’s estate for IHT purposes is that to which they were not beneficially entitled at the time of their death.
- Excluded property: This might be where the “remainderman” (a couple’s child) dies before the life tenant (the widow) who is using a property but was to leave it to the child. Their interests pass under will or intestacy, but do not form part of their estate for IHT purposes
- Life assurance policy proceeds: If someone writes a life assurance policy in trust the eventual pay-out is never part of their estate, and the proceeds go straight to a named beneficiary instead, untouched by IHT.
- Pension plan pay outs: Pension plans can pay out lump sum payments on death on a discretionary basis to the deceased’s family, and these also do not form part of their estate for IHT purposes.
If someone writes a life assurance policy in trust the eventual pay-out is never part of their estate, and the proceeds go straight to a named beneficiary instead, untouched by IHT
There are other ways that an asset can fall out of the estate for IHT purposes, such as gifting and the survivor living for seven years subsequently and Business Property Relief. Assets amenable to BPR can fall fully or partially out of the estate after two years, and the relief could apply to up to 100% of shares in an unlisted company.
Take a full inventory of your wealth
What you will hopefully appreciate by now is how important it is to understand the totality of what you own, where it is and how you hold it. This is the start of any meaningful wealth management strategy, but particularly so in the complex area of IHT.
One solution which canny High Net Worth Individuals often use today to great effect is to take out a life assurance policy written in trust – and therefore not part of their estate for IHT – which is intended to pay off the IHT bill for the rest of the estate
We have also seen that there are both traps and tricks when it comes to whether assets do indeed form part of your estate for IHT purposes. Gifting ‘incorrectly’ is a common error. Meanwhile, people frequently neglect to consider paying tax bills which are going to be unavoidable. One solution which canny High Net Worth Individuals often use today to great effect is to take out a life assurance policy written in trust – and therefore not part of their estate for IHT – which is intended to pay off the IHT bill for the rest of the estate.
If you would like to learn more about how your family can engage a wealth manager to help you mitigate Inheritance Tax exposures across the generations, please get in touch.
Important information
The investment strategy and financial planning explanations of this piece are for informational purposes only, may represent only one view, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment and financial planning decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.
