How can savers and investors make the most of their ISA allowance? Read our special report to find out.
Inheritance tax (IHT) has been a money-spinner for the Government in recent years. While savers and investors have benefited from increased allowances in many areas, IHT has been more punitive.
Since Individual Savings Accounts (ISAs) were introduced 20 years ago, for instance, the allowance has grown from just £7,000 then to £20,000 today.
In contrast, the IHT threshold has been stagnant for a decade. The individual allowance has remained at £325,000 since April 2009, with a standard rate of tax of 40% on anything left in your estate above that level.
Had the threshold kept pace with inflation since then, it would be worth £436,566, according to data from investment platform Hargreaves Lansdown. Compounding this, the average house price in the UK has grown by almost 50% in that time, Hargreaves shows.
This, says Kevin Broadbent, director of personal finance planning at Smith & Williamson, means that more and more ordinary people have been dragged into the IHT equation.
The receipts from IHT have increased by an average of 10% a year over that decade and the Government’s coffers were boosted to the tune of £5.2 billion from IHT alone between April 2017 and March 2018.
While not all people will be hit by IHT, the most recent figures – for the 2015/16 tax year – show 24,500 estates were subject to the tax.
Broadbent says there is always strong interest in IHT seminars because, while most people know they will be liable, they’re generally unsure what their options are. Below, we outline a few ways to mitigate your potential IHT bill with help from the experts.
Allowances
Firstly, it’s important to understand your IHT allowances. The nil-rate band is £325,000, which is the maximum your estate needs to be worth in order to qualify for IHT. Couples can pool their allowances together to make an effective nil-rate band of £700,000.
If your estate includes a family home, the newly introduced residence nil-rate band will apply. This is currently £125,000 but will increase by 2020 to £175,000, meaning the total allowance for couples will hit £1 million before IHT kicks in.
Spend
First, Broadbent says simply spending your money is the best and easiest way to lower your estate. “If you spend your money, it’s not in your estate for IHT purposes,” he explains.
Gift
Another good way of eliminating future IHT liabilities is giving money away to family members while you’re still alive. Gifts between spouses and civil partners are always tax-free, unless your other half was born outside the UK, in which case there may be limits.
Any gift made to an individual can potentially become exempt from counting towards your estate for IHT purposes, providing you live for seven years after making it.
Should you die within seven years of making the gift, the value of any gift that exceeds your nil-rate band of £325,000 will be charged on a sliding scale. This goes from the full IHT rate of 40% if you die within three years of gifting to 20% of the full rate (8%) within six to seven years.
“You should therefore consider the potential tax charge when making a gift if you are not reasonably confident that you will live for more than seven years,” says Charles Calkin, partner and financial planning consultant at James Hambro & Partners.
The annual gifting allowance is £3,000, while you can also make small gifts of up to £250 per person. “Lifetime gifts can make a big difference to the financial circumstances of your family,” Hollands adds.
These gifts could come in the form of funding a Junior ISA or child pension, helping with education fees, clearing graduate debt or be put towards a deposit on a property.
The downside of gifting absolutely, counters Broadbent, is that you lose control over what happens with the gift. Those who wish to maintain a degree of control can gift into trust for the benefit of a third person.
With a trust, the creator, or settlor, stipulates how the trustee runs it. You can also decide when the beneficiary can gain access to the trust, when they turn 18 or 21, for instance.
Invest
As we’ve previously outlined, investing can be a good way of avoiding IHT on part of your assets. Investing in AIM stocks, for example.
Many firms offer bespoke AIM portfolios for investors, as shares listed on London’s junior market qualify for business property relief if held for more than two years. While they still count as part of your estate, they will be taxed at 0%.
It may be counter-intuitive for a 70 or 80-year-old to invest in what is essentially a smaller company, but it can, in fact, be a lower-risk way of mitigating IHT. That’s because the amount of time before the assets become IHT-exempt is shorter – two years instead of seven – than for potentially exempt transfers.
You can now also put AIM shares into your ISA, which Broadbent suggests can make “the ultimate ISA [with] no income tax, no capital gains tax and no inheritance tax after two years”.
Protection
You can also take out life cover, written in trust, which will pay out to cover the IHT bill when it becomes due, says Sarah Coles, personal finance analyst at Hargreaves Lansdown.
As Broadbent notes, this won’t reduce your liability, but it does help to reduce the amount your beneficiaries have to pay in tax on your estate.
“For some people, it’s a perfect solution,” adds Broadbent, “because they don’t have to worry about gifting, investing or other areas. They know that when they pass on as long as the premiums have been maintained there’s a sum of money for the family to pay the [IHT] bill.
“For others it’s a complete anathema – paying chunky premiums for up to 40 or 50 years just doesn’t feel right. You would only recommend such a policy to clients if you’re confident that they can afford it for not just the initial period but for the duration of their lifetime.”
Pension Considerations
Pensions are increasingly coming into people’s thinking when looking at their IHT liabilities. This is because your pension can be passed on IHT-free if you die before your 75th birthday. If you live past 75, the pension is taxed at the marginal rate of the recipient.
That’s generally less than the 40% IHT rate. “We’ve seen a lot of people change their strategy and, if they’ve got a choice, draw their retirement income from other sources and leave their pension assets intact,” claims Broadbent.
