Inheritance Tax case study

Inheritance Tax payments have reached an all-time high of £7.5 billion for 23/24. By Jessica Partridge, who heads the Trusts and Tax team at Mayo Wynne Baxter.

So what can you do to try and save on Inheritance Tax? Quite a few things actually!

Case study

A married couple, Emma and Paul. in their sixties have two children in their late twenties. Their assets comprise:

• House £700,000 (main residence)

• Rental property £275,000

• Bank accounts £100,000

• Life insurance £400,000

• Investments £200,000

Total £1,675,000

Emma has a final salary pension and their joint income levels are around £100,000 per year.

Their wills leave everything to each other and then down to their children equally.

On the first to die there is no Inheritance Tax (IHT) as the assets pass to the spouse free of IHT. On the death of the survivor of them, when the assets pass down to their children, IHT will be payable as follows:

Can any allowances be claimed here?

The nil rate band (tax free amount) of both parents can be claimed here which are currently £325,000 for each, so £650,000 in total. In addition, there is a residential nil rate band and again in this scenario it can be claimed twice, currently £175,000 so another £350,000 tax free bringing us to £1 million. So the executors of the will have £1 million free of IHT but the amount poking above that threshold is taxed at 40%.

£1 million IHT free

£675,000 charged at 40% = £270,000

An IHT bill of £270,000 has to be paid to HMRC typically within 6 months of the date of the second death.

Could they have undertaken estate planning to minimise the IHT bill?  Yes, they could reduce the IHT payable to £0 and here is how.

The life insurance

A nice and easy asset to tax plan with as it will only be paid out on death and, when it’s given away, it has a tiny value. Putting this into a trust, so it does not form part of the estate. will save £160,000 of inheritance tax. A bespoke trust can be drafted, or one can contact their life insurance provider to see if they have a standard document. Beware of the latter though, as I have seen an ambiguously drafted standard from trust go to litigation.

The rental property

The income from the rental property is not essential for the client’s income needs and they consider giving this asset away to their children. It was purchased 20 years ago for £125,000 and it is not their main residence. By giving this asset away outright to their children there would be an immediate capital gains tax (CGT) bill of £35,000. They could pay the CGT, survive 7 years and save £110,000 on IHT.

If they did not want to or could not pay the CGT upfront using a discretionary trust would be the answer here. By giving away the asset into trust, in their lifetime and surviving for 7 years, the value would not form part of their estate for IHT. By using this kind of trust the CGT can be rolled over and rather than paying the £35,000 the trust inherits the original acquisition value for CGT. After 7 years a saving of £110,000 in IHT is made.

Note – if an individual gives more than the nil rate band (£325,000) away into a discretionary trust there is an immediate charge to IHT at 20% of the amount over the £325,000 and if they die within 7 years the full 40% is chargeable. On the assumption that they have a full nil rate band available to them.

Also note – Joint settlor discretionary trusts, for example for a married couple, have a threshold of £650,000 as both nil rate bands are counted. This can be useful for property with a value over the £325,000 held jointly. CGT hold over relief is also available here too.

The income

Many people know that one can give £3,000 away each year and there is no IHT consequence. More can be given away, but an individual must survive for 7 years in order for it to fall out of their estate for IHT. If one died within that period, their nil rate band is reduced by the amount of the gift.

What many people do not know is that surplus income can be given away without any IHT consequence. This is because IHT is a tax of capital and not income! So, for example, if £100,000 of income was revived but only £50,000 spent in that year the surplus can be regularly given away as a gift out of income. There is a useful spreadsheet used in the IHT400 return, which I always refer my clients to, if they are considering these types of gifts. It’s called an IHT403 and on the last page sets out all of the information HMRC requires in order for the executors to claim the exemption. As with all of these things, it is easier if done in advance!

Every person and family is different in the assets held, their wishes and family complications. This area of law is complicated but there can be considerable IHT savings to be made.

Mayo Wynne Baxter

01273 477071
jpartridge@mayowynnebaxter.co.uk
www.mayowynnebaxter.co.uk