The headline rate of inheritance tax may seem galling at 40% of an individual’s estate. However, the rate is often very much lower.
When calculating an individual’s liability, it’s very common that there are two variables that mean planning is not needed or irrelevant.
Firstly, it may be desirable to retain assets that might be needed in one’s lifetime to meet a certain standard of living, and also to cover unexpected expenditure. For example, long term care needs or maintenance on homes, etc. The second consideration is that it is also possible to have a very significant estate and pay very little inheritance tax.
Don’t give it all away!
The cost of long term care in Surrey, is typically one to two thousand pounds per week (c. £80k pa is very common), the highest level will be for very best residential care home or care in your own home – which is becoming increasingly popular. If you are unable to look after yourself, particularly if this is for reasons of frailty (as opposed to the stereotype of mental incapacity) would you not want the best possible care?
Why inheritance tax is almost never 40% of an individual’s estate
With respect to the second point above, the answer needs more detail.
And it’s been said that
Inheritance Tax is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue (now HMRC)
Former Labour Chancellor Roy Jenkins
I have just been doing some planning for a couple who have £800,000 in property assets, two private pension funds totalling £800,000 and then around £400,000 in investment ISAs and cash deposits.
These clients were new to Wingate, and whilst retiring, they were concerned that a significant proportion of these assets would be lost in the event of their death. They had read an article in a well-known national newspaper that they might be best to put their house in trust and did not want the Chancellor to take 40% – more than their three children each would see!
I explained their first valuable allowance would be the “nil rate band”. Between the two of then, they’ll have £650,000 which is inheritance tax exempt. Under current rules this could increase to as much as £1 million if they leave their property assets to their children, which is their intention.
Their wills, nearly a decade old, were unnecessarily complex, and potentially disadvantageous (a half-share of the house went to a trust, not the children) and I explained there may well no longer ne any need for complicated planning, as the nil-rate band automatically passes to the surviving spouse. As I elaborate on below, this means that in the event of the first death, the survivor will have the full enjoyment of the nil rate band, and if they can afford to do so they can make gifts that will fall outside their estate as long as they live seven years, meaning that it’s uncommon that somebody would look to make gifts on first death, including to a trust, as part of their will for tax reasons.
The next consideration that we discussed, what that I expected the pension funds to be exempt from inheritance tax. Under the current rules, a pension fund can normally be passed to a surviving spouse and then on to dependents (or indeed anybody) without inheritance tax, irrespective of whether the plan has been touched or not, and irrespective of the deceased’s age.
Assuming a pension fund is not spent to maintain a lifetime income, then this asset is outside this couple’s estate. The recipient(s) can allow the pension to grow free of income and capital gains tax and does not form part of the recipient’s inheritance taxable estate, nor contribute to their maximum pensions’ allowance.
The ISAs and cash is potentially inheritance taxable, so the advice I have given on the current income strategy is to draw more from these sources and less from the pension.
You can see that for a total estate that is valued at £2 million, £1.8m is exempt (£650k of any asset, £350k of the property, £800k of the pension). This is a potential tax liability of £80,000 if they were both to die in the near future: 4% – not 40%!
Given their relatively young age (in their 60s), the bit that is taxable will be drawn down over the next few years, and likely the value will reduce. In the meantime the pension value would be expected to increases, which is exempt from inheritance tax, and still has their full 25% tax-free allowance to draw.
Summary
It is almost never worth getting tied up in overly complex planning on inheritance tax, I am extremely skeptical on schemes that involve the family home, and with decent, “basic” planning inheritance tax may well not be an issue. It is imminently relevant this couple have a c. three decade life expectancy, tax is normally only due on second death and my recommendations should be flexible enough to adjust to changing legislation, their circumstances and the overall investment climate. This is the benefit of the best Financial Planning advice!
