Year End Inheritance Tax & Estate Planning

As we approach the end of the financial year, it is important to review your financial and taxation position.  Whilst in our last article in this year end tax planning series, we took a look at capital gains tax planning, in this article, we highlight some of the areas you should consider when it comes to inheritance tax and estate planning.

The key to successful estate planning is to first make sure that arrangements are in place so that your wishes for your estate are properly carried out and secondly that opportunities are taken to reduce the inheritance tax liability.

Inheritance tax planning is therefore considered on a long-term basis – both in the context of lifetime giving and the arrangements to be made in your Will.

The most important step with inheritance planning is making your Will and keeping it up to date.

If you gift assets in your lifetime, rather than cash, then capital gains tax may be an issue.  And of course, when gifting any assets, you should always contemplate the impact on your financial position so that your lifestyle is not compromised.

Basic planning

There is some straightforward planning all individuals should consider:

• Using the annual gifts exemption of up to £3,000 in a tax year.  If you made no gifts in 2023/24, then the exemption for that year is carried forward meaning that you can make gifts of up to £6,000 on or before 5 April 2025 free of inheritance tax
• Using the small gifts allowance of up to £250 per donee
• In the case of marriage, gifts of £5,000 to children, £2,500 to grandchildren and great grandchildren, and £1,000 to anyone else are also exempt.

 Normal expenditure out of income

 Regular gifts out of excess income can also be exempt from inheritance tax as normal expenditure out of income.  You will need good documentation to prove that you made the gifts out of excess income rather than from capital.  Importantly, there is no limit to the amount of relief that can be claimed either in lifetime or on death.  If you have excess income, it could therefore be used to fund a discretionary trust with no lifetime change to inheritance tax being payable. 

More substantial gifts

Gifting assets or cash during your lifetime will, provided you do not reserve a benefit, fall outside of your inheritance tax estate if you survive seven years  The amount of inheritance tax payable will progressively reduce with taper relief if you survive more than three years from the date of gift.

The nil rate band

Many more estates are now subject to inheritance tax, which is payable if your estate exceeds the nil rate band of £325,000.

Transferable nil rate bands

The estate of a surviving spouse or civil partner could benefit from the proportion of the unused nil rate band on the earlier death of their spouse or civil partner, meaning a combined nil rate band of up to £650,000 can be available on the death of the survivor.

Residence nil rate band

Where a residence is passed on death to direct descendants such as children or grandchildren, an additional nil rate band of £175,000 is available.

The residence nil rate band can only be used in respect of one residential property which has, at some point, been a residence of the deceased.  There is a tapered withdrawal of the residence nil rate band for estates with a net value (after deducting any liabilities but before reliefs and exemptions) of more than £2 million.

The residence nil rate band cannot be greater than the value of the property at the date of death.

Transferrable residence nil rate band 

A surviving spouse may be entitled to an increase in the residence nil rate band if the spouse who died earlier has not used, or was not entitled to use, their full residence nil rate band.  The increase applies regardless of when the earlier death took place but is subject to the tapered withdrawal if the spouse who died earlier had an estate with a net value of more than £2 million.

Relief for downsizing

Relief will be available when a person has downsized or ceased to own a home.  Assets of an equivalent value, up to the value of the residence nil rate band, can then pass on death to direct descendants.

Relief for debts and loans

Relief for debts and loans is available against the taxable value of an individual’s estate.  Where beneficial, the liability should be secured against taxable assets in your estate.

Care is needed with anti-avoidance provisions which can disallow the deduction.  These include the expectation that the loan will be repaid out of the estate unless there are genuine commercial arrangements for the debt or loan to continue.

Loans taken out post 6 April 2013 to purchase assets that qualify for agricultural or business property relief will, regardless of how the loans are secured, be deducted from the value of the property qualifying for agricultural or business property relief.

Trust arrangements created in lifetime

Proposals for lifetime giving into Trust need careful consideration as such transfers attract an immediate charge to inheritance tax unless the property being transferred attracts relief as either business property or agricultural property, or is exempt as normal expenditure out of income.

Discretionary Will Trusts

The emphasis of inheritance tax planning has moved away from maximising the use of the nil rate band on the first death with consideration instead being given to non-tax issues.

There could still be a number of occasions where the first of a married couple or civil partnership to pass away may wish to establish a discretionary trust in their Will.  These include:

• Where there are children from a former marriage
• There may be a desire to avoid children inheriting assets outright
• Further inheritance tax savings could be secured using a loan arrangement between the trustees of the Will Trust and the surviving spouse, if and when funds are needed
• Investments held by the Discretionary Will Trust may increase in value at a greater rate than the increase in the nil rate band, especially given this exemption is presently frozen.

Deeds of variation

Deeds of variation can be very effective at reducing inheritance tax liabilities but they can also allow a beneficiary under a Will or intestacy to redirect part or all of the estate they have received to another person.

Married couples and civil partners

Most planning opportunities available to married couples and civil partners do not apply to unmarried couples who are likely to face greater issues over the payment of inheritance tax. 

Alternatives to trust arrangements

Consideration is increasingly being given to the use of a Family Limited Partnership or Family Investment Company to hold family wealth given the inheritance tax charges on Trusts.

Different share classes can be created – one to be held by the donor giving control with the other to be held by the donees carrying the economic benefits or the value of the wealth.

Legacies to charity 

Gifts to charity are exempt from inheritance tax.  In addition, where at least 10% of your estate is given to charity, the rate of inheritance tax is reduced from 40% to 36%.

Life assurance  

It is usually possible to arrange life assurance written in trust to fund any exposure to inheritance tax.  The beneficial effect of life assurance is often under-estimated in inheritance tax planning.  The earlier in your lifetime that life assurance is secured, the lower the premium is likely to be.

Valuation

A gift of an asset is an event for both inheritance tax and capital gains tax.  Even though inheritance tax may only arise if the donor dies within seven years of the gift, unless the capital gains can be deferred to the donee, there will be capital gains tax on the difference between the open market value and the cost of the asset gifted.

Business and agricultural property

Some assets qualify for either 100% or 50% relief from inheritance tax as either business assets or agricultural assets.

Securing the relief is dependent on owning the asset for at least two years – longer for some agricultural property – before death.

The main classes of assets qualifying for business property relief are:

• Own trading businesses
• Trading partnerships
• Shares in unquoted trading companies

The agricultural value of agricultural property, either farmed in hand where vacant possession can be obtained within two years or held under a Farm Business Tenancy, will also qualify for this relief from inheritance tax.

Arrangements to sell the assets on death can prevent either relief from applying if not carefully structured.

From 6 April 2026, the existing 100% rate of relief will only be available for the first £1million of property qualifying for business property and agricultural relief. Thereafter, the rate of relief for both business property relief and agricultural property relief will be 50% of the standard 40% rate of inheritance tax for any qualifying assets over the £1million threshold.

These new rules will apply to lifetime transfers made after 30 October 2024 if the donor dies on or after 6 April 2026. 

Shares in AIM listed trading companies now only qualify for 50% relief from inheritance tax.

Tax efficient Wills

Structuring your Will tax efficiently will usually involve:

• Specific gifts to individuals, say your children, but not your spouse or civil partner, of assets qualifying for business or agricultural property relief or falling within the nil-rate band
• Specific gifts to a discretionary trust, of which the spouse or civil partner can be a beneficiary as well as children, for assets qualifying for business or agricultural property relief (and possibly the balance of the nil rate band)
• Gift of the remainder of the estate either absolutely or on life interest trusts for the surviving spouse or civil partner.

We hope you have found the suggestions above helpful. In our next article in this series, we will be looking at pension planning and tax efficient savings.  As always, please contact us to discuss your circumstances with you.

These articles have been written to provide a general guide to potentially highly complex issues. Whilst great care has been taken in the production of these articles, they are intended to provide the clients and friends of Ritchie Phillips LLP with an outline of the issues individuals, families and trustees should consider and you should seek specific advice before taking or refraining from any action.