How could I reduce my potential inheritance tax bill?

Introduction

In the 2020-21 tax year HMRC collected £5.4 billion in inheritance tax, an increase of 4% on the 2019-20 tax year. HMRC recently announced that they collected £6.1 billion in inheritance tax between April 2021 and March 2022, showing that the upward trend of inheritance tax receipts is continuing.

This increase is significant and highlights the importance of considering inheritance tax planning as part of your wider financial plan. Here we overview a couple of the factors causing the rise in inheritance tax and two methods of mitigating inheritance tax.

When is Inheritance Tax (IHT) paid?

Individuals have a personal IHT allowance of £325,000 (called the nil-rate band). The value of the estate up to £325,000 is taxed at a zero rate. The value of the estate over £325,000 is subject to IHT at a rate of 40%, or the lower rate of 36% if 10% of the net estate is left to charity. Individuals who own their property and leave it to a direct descendant also have a second IHT allowance (called the residence nil-rate band) of £175,000, potentially meaning the first £500,000 of their estate is taxed at a zero rate.

Why are IHT receipts increasing?

Firstly, the IHT allowances for individuals have been frozen until the 2025-2026 tax year, rather than keeping pace with inflation, meaning the real value of the allowance is decreasing. Over time this has the effect of increasing the proportion of an estate that is not covered by an allowance.

Secondly, the general trend of rising asset prices, particularly property, increases the total value of the estate on death. This increases the amount of IHT due on the estate. This is even more problematic when the allowances are not increasing at the same time.

Thirdly, the COVID-19 pandemic has seen an increase in the number of “excess deaths” versus previous years, meaning more estates are being administered and more IHT returns are being submitted. With COVID-19 disproportionately affecting the older generations, who are more likely to have an IHT problem, there has been a notable jump in IHT paid.

How can I mitigate IHT?*

There are several methods for reducing or even eliminating the IHT liability of an estate, including:

  1. Investing in companies listed on the Alternative Investment Market (AIM)**
  2. Using Trusts to remove value from your estate

AIM is a sub-market of the London Stock Exchange where shares can be traded. AIM typically consists of smaller, earlier-stage companies, looking to finance their growth. The IHT benefit of AIM investments is that the majority qualify for Business Property Relief (BPR) on death after they have been owned for two years. When BPR applies the value of the shares qualify for up to 100% relief from IHT.

Trusts are legal arrangements set up to remove value from your estate. Allocating parts of your estate into a trust throughout your life, providing certain conditions are met, can exempt these assets from being considered in an IHT calculation. There are a variety of trust structures, with complex and differing rules, so it is important to seek professional advice before setting up a trust.

How can Carpenter Box Financial Advisers help?

Inheritance tax planning is a complex area and something that should be considered as part of a wider financial plan, rather than a single objective. We can help you formulate a financial plan where IHT mitigation is a key component and ensure the method of mitigation is suitable for your personal circumstances. Please feel free to call us on 01907 534587 or contact us via our website.

* The Financial Conduct Authority does not regulate tax advice

** Investments in AIM shares are high-risk and the value can fall as well as rise. Investors may not get back what they invest.