Blunt tool
“IHT is a very strange tax,” Mr Roxborough admits.
“Firstly, it’s a very blunt tool, levelled at a rate of 40 per cent at almost all assets above the nil rate band, and can also be used retrospectively on gifts already given by the deceased if the timespan between gift and death is insufficient.
“That's the bad news, but the good news is that, with a little planning, it is also an eminently avoidable tax – perhaps more so than any other.”
Gifting, as Tim Bennett, head of education at Killik & Co, points out, is one of the main ways to reduce inheritance tax legally.
“Under the potentially exempt transfer rule, for example, assets can be given away to anyone and, provided the gift is made more than seven years prior to the death of the donor, the asset will not normally form part of their death estate,” he explains.
“One caveat, however, is that a gift may be subject to capital gains tax at the time it is made so, once again, this is an area that needs careful thought.”
Helen O’Hagan, technical manager in Prudential’s technical team, says advisers may want to consider exemptions as another way to reduce the amount of IHT payable on a client’s estate.
She outlines three exemptions:
- Each tax year an individual can gift up to £3,000, which can be useful if paying premiums on a life policy to cover the inheritance tax.
- Each year an individual can gift £250 to as many individuals as they like, as long as it is not used in conjunction with other exemptions.
- There are also exemptions for gifts on marriage, gifts to help with the living costs of dependents and gifts out of surplus income.
Trust planning
Ms O’Hagan acknowledges: “There are many ways to do inheritance tax planning with the use of trusts, which have been used for many years. These trusts will normally have been through a process to ensure they are ‘fit for purpose’ as a tool to help mitigate IHT.
“An adviser will guide a client through a number of questions to ascertain the type of trust which is best suited to a client’s particular circumstances.
“A big factor is the access that the client needs from those funds now and in the future.”
She lists the three most common IHT trusts:
1. Gift trust – client must be willing to give up all access to funds.
2. Loan trust – client has access to his/her capital but not the growth on the investment.
3. Discounted gift trust – the client carves out a fixed regular payment stream for his/her lifetime.
One of the main pitfalls to avoid is giving away too much, too soon.
This might sound obvious, but Scott Gallacher, chartered financial planner at Rowley Turton, cautions he has seen this happen before.
“Gifting money early, either directly or via trust arrangements, can be key to reducing your inheritance tax liability, but it’s important to ensure that you do not leave yourself at risk of running out of money yourself,” he says.
