As your estate grows so does the potential inheritance tax bill. What steps can you take to minimise tax while keeping hold of your underlying wealth?
The simplest way for someone to reduce their estate for IHT purposes is for them to pass their wealth to their beneficiaries by making gifts during their lifetime. However, the maximum that an individual can give away to others entirely exempt from IHT is £3,000 per year. While there are a few other special exemptions, e.g. gifts to those getting married, you can’t be sure the opportunity to use them will arise.
Trap. Where an individual makes gifts totalling more than £3,000 in value per year, the excess will be liable to IHT if they die within seven years.
Keeping the capital
HMRC has a number of anti-avoidance rules to stop you giving away your wealth, but being able to recall it if the need arises. However, there are legitimate ways around these. For example, the insurance industry has created several investment products to do the job. The drawback with these is that like all marketed investments there’s a middleman and a cost involved which will eat into your capital.
Insurance loan schemes
One type of IHT-efficient insurance product, so-called loan schemes, involve lending money to a trust which invests it in a bond. Beneficiaries are entitled to the income from it, but the capital is repaid over a period of 20 years. Rather than pay the insurance company for managing this type of scheme you can create your own loan scheme. Not only does this save on insurance company charges, it’s more flexible.
Your own loan scheme
An IHT-effective loan scheme is relatively straightforward to set up. It only requires your parents to lend money, interest free and repayable on demand, to one or more of their chosen beneficiaries. The loan by itself doesn’t reduce the value of their estate, because while their cash goes out it’s ultimately repayable to them and so has equal value. The IHT saving comes in two parts.
Part one - freezing the estate
The cash lent reduces savings and thus the income it generates. If the money hadn’t been lent, any interest etc. it produced would add to the value of the estate. In effect the value of the loan is frozen. Any growth in value goes to the beneficiaries who can invest it how they wish and take the resulting income.
Part two - writing off the loan
Over time it may be decided that not all of the loan needs to be repaid. £3,000 per year can be written off IHT free using the annual exemption. This will reduce the amount repayable and therefore the value of the estate.
Tip. It’s advisable to get a solicitor to draw up the loan agreements to ensure they achieve their purpose. If part of a loan is written off, it must be done by formal deed.
As the old adage goes; there is nothing certain in life apart from death and taxes. The first you can do nothing about, the second you can. Take time to plan your affairs to help your beneficiaries get more from your estate than the tax man.
Happy tax saving!