Anyone, with an estate value that could breach the current IHT threshold of £325k per person (+ £150k if you are leaving your home to direct line descendants), should be looking at ways to pay less inheritance tax.
An example scenario:
Mary, who is 64, was widowed in 2015. Her husband left £50k to each of their 2 children. Mary owns her home worth £950k, her business worth £500k and a £280k ISA. She also has £200k in a savings account that she wants to gift to her children. Neither of her children want to take over the business.
In 2019, Mary’s Nil Rate Band (NRB) is £850k (£325k personal NRB + £225k left of husband’s NRB + 2 x £150k main residence NRB). The total value of Mary’s estate is £1.93m.
If she does nothing, the IHT bill will be (£1.93m – £850k) x 40% = £432k
Leaving the house and £548k for her children.
So what are her options?
Mary could sell her business and then, within 3 years, take out other investments that qualify for Business Relief. This typically involves investing in the Alternative Investment Market (AIM), which is higher risk than the main stock market so not suitable for everyone. She would only pay 10% Capital Gains Tax (CGT) on the sale proceeds as she qualifies for Entrepreneur’s Relief. The AIM shares could pass to her children with no IHT liability.
Inter Vivos Life Insurance
If Mary is still alive 3 years after the £200k gift, the IHT liability reduces in steps from 40%, to 0% after 7 years. She could take out Gift Inter Vivos life insurance to cover the remaining IHT liability if she dies within the 7 year period.
Mary is a higher rate taxpayer and takes a tax free income from her ISA. Cashing in this ISA and purchasing an Onshore Investment Bond, would allow her to continue taking an income of up to 5% per year without an immediate tax liability. The bond can be set up so, on Mary’s death, the trustees can assign the bond to the children with no liability to IHT.
Reduction in IHT Liability
The remaining IHT payable on Mary’s estate is now (£950k – £850k) x 40% = £40k
Leaving the house and £890k of assets for her children (£980k – £50k CGT – £40k IHT)*
As this example shows, IHT planning can be complex but legitimate methods to pay less inheritance tax can be very beneficial.
*Discounting insurance premiums, investment gains/losses, and charges.