There are many different approaches that can be taken to IHT planning, each having their own merits and being appropriate to different individuals in different circumstances. Making gifts is one of the most common approaches, whether it is a gift to an individual or into trust, or even to charity.
As a starting point, every individual has an annual gifting exemption of £3,000 and this gift can be made to anyone. If this is not used, it can only be carried forward to the following tax year and no later. In addition to this, individuals are also able to make small annual gifts of up to £250 per person, on the basis that they have not gifted to that person using another exemption.
One option is to simply start spending down capital. This may not be achievable for individuals with large estates, however for many this can be an effective step in helping reduce their overall estate. In addition to IHT planning, it may allow people to pursue their dream holidays or undertake “bucket list” activities that they otherwise would not have done. This should however be caveated, in that spending capital would only work on the basis that an asset that increases in value is not purchased and having the opposite of the desired effect – increasing the IHT liability.
For some people, their current level of wealth is not an issue regarding IHT, however a forward-thinking approach is required. IHT may not be an issue just yet, however with a high level of surplus income over their annual and expected future expenditure, capital is likely to accrue. In this instance, the ‘gifting out of surplus income’ exemption would apply, in addition to those already mentioned. There are certain criteria that need to be met for this exemption to apply however, which are:
- It will be part of the individual’s normal annual expenditure
- It was indeed made out of surplus income
- The individual’s standard of living was maintained as a result of the gift
‘Surplus income’ does also include dividends from all sources, even if they are not received and are reinvested. In addition, savings interest and interest on any fixed income unit trusts/OEICS is included. This can greatly increase the level of surplus income an individual has and therefore the amount available to gift and be exempt.
In all of the above instances where a gift is made, it is irrelevant whether the individual survives 7 years or not, as the gift is immediately outside their estate. Whenever any gift is made, this should be documented and records of gifts maintained in order to prove the gifts are exempt. Failure to do so can result in issues for executors when dealing with an estate after death and could even lead to the gifts falling back into the estate, if they cannot be proved to be exempt.
Throughout their lifetimes, many people have built up assets and can find that their overall level of wealth exceeds all nil rate bands available and that IHT would be due should they die. Under current rules, defined contribution pensions are outside one’s estate for IHT purposes. Something as simple as drawing on capital that is held in cash/investments as opposed to a pension to support people in retirement can make a large impact, as this helps spend down and reduce the assets that are tested against IHT. This strategy can often save income tax too, with the right planning.
There are other rules surrounding the inheritability of pensions. Should a pension holder die before age 75, then the chosen beneficiaries of the pension can often receive the fund free of tax. They are able to leave it in a pension wrapper using a “beneficiary pension” or can withdraw the fund at any time, either in full or as an income. Should a pension holder die after age 75, then fund still passes to the beneficiaries and is outside the estate for IHT purposes, however income tax would be due on any funds drawn out at the beneficiary’s marginal rate.
IHT planning is never just a one off exercise. An effective IHT strategy needs to be implemented and reviewed regularly to ensure the objectives of the client are still being met and what is being done remains appropriate. Circumstances can, and often do, change over time and in addition, it is often the case wealth grows over time, meaning further planning is required. Changes in legislation are something that cannot be predicted, but this is also another factor to take into consideration and reviewed.