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Getting comfortable with Estate Planning

Inheritance Tax (IHT) is often quoted as a ‘voluntary tax, paid by those who distrust their heirs’. The reality is somewhat more nuanced. A multitude of factors come into play, and most of the options available to families will involve some degree of deliberation and debate.

To outline the scale of the issue, receipts from IHT are projected to reach £5.6bn in 2021/22. The figure has risen steadily over the last 10 years, from a base of £2.7bn (OBR). Inadequate financial planning, coupled with rising asset prices, and frozen tax allowances all contribute to the situation.

The basic rules

IHT is usually levied on the value of all the assets in an individual’s estate on death, after deducting any liabilities, exemptions, and reliefs. Assets left to a spouse or civil partner of the deceased are usually exempt, as are assets left to a charity. Pensions do not typically feature in the calculation.

The rate of IHT is normally 40 per cent on the value of an estate above a threshold of £325,000. This threshold is frozen until 2025/26. Any unused threshold may be transferred to a surviving spouse or civil partner, increasing their combined threshold to up to £650,000.

There is an additional transferrable main residence nil rate band of £175,000 available when a home is left to children or other direct descendants. However, this tapers away to zero for estates valued north of £2m, at a rate of £1 for every £2 the estate exceeds £2m.

There is an additional transferrable main residence nil rate band available of up to £175,000 per individual when a home is left to children or other direct descendants. However, this tapers away to zero for estates valued north of £2m, at a rate of £1 for every £2 the estate exceeds £2m.

Finally, the rate of IHT is reduced to 36 per cent if 10 per cent or more of the net value of the estate above the threshold is left to charity.

Where to start

The starting point for any estate planning exercise is to examine your own financial needs. In broad terms, effective IHT solutions tend to involve forgoing some benefit from your assets. It stands to reason, that the first port of call is to quantify the cost of your own retirement and potential care costs. From there you can conservatively start to identify the scope for allocating capital and/or income to this area.

What are the typical steps taken to reduce your IHT liability?

At Kellands Chartered Financial Planners, the foundation to an estate planning exercise is to know your current financial position on death (first and second death for married couples and civil partners).

First, review your will to ascertain the current benefit to your beneficiaries, factoring in the IHT liability. Alongside this, consider any life cover currently in place. Cover ought to be written in trust, with beneficiaries nominated and a letter of wishes in place. Finally, review pension assets, which require their own separate death benefit nomination. The three should be viewed in tandem to appreciate the starting position. How comfortable are you with this, and are you motivated to undertake further planning?

Next, be selective about which assets you spend during your retirement. Pensions do not typically feature in the IHT calculation. If viable, it is common to preserve pensions, and view them as a vehicle to efficiently pass through to the family. Checking your specific pension is crucial, as individual plans have different options available on death. Also, simply naming a spouse on a death benefit form could prove very costly indeed. Professional guidance here is essential.

Certain assets attract Business Relief, meaning they are exempt from IHT if held for at least 2 years before death. These assets typically include shares in small unlisted companies, but the relief also extends to certain AIM listed company shares. Whilst deemed higher risk, there are portfolios which are aimed at private investors, and designed to attract Business Relief. It is an area not to be overlooked, with our preferred asset managers in this space, constructing portfolios which focus on wealth preservation.

Other common routes include making gifts, either outright or to trusts. There are various gifting allowances, which are effective immediately. These include a £3,000 annual gifting allowance (per spouse), and the ability to gift surplus income each year. Gifts made outside of the various allowances can be effective, but typically only after 7 years.

As an alternative, it is possible to insure your liability with life insurance. Clearly there is a personal cost associated with this, but it is another option for consideration, which provides a means to meet the tax liability.

Getting comfortable

The later in life you engage in estate planning, the more comfortable the exercise tends to be. Your own needs are often better known. With time comes family maturity, children having established their careers, and reached genuine financial independence through their own endeavours. Their family situation has been established, hopefully providing a more stable base from which to plan from. This will not always be the case, but with time, tends to come the ability to better assess the preferred route.

Readers will want to help their children to succeed, but that does not necessarily mean offering up a free ride. The struggles in early adulthood can be formative in terms of work ethic and values. It is why people find paying for a grandchild’s nursery fees an easier consideration than making a capital gift, with no predetermined purpose.

Unfortunately, waiting brings with it another risk, notably the 7 year survival rule. The use of trusts is a powerful option in this aspect. They do not circumnavigate the 7 year rule, but control is retained, with benefit to the family being distributed over time under the discretion of a trustee. As alluded to earlier, there are opportunity costs with most routes, and trusts themselves incur tax as well as ongoing professional and investment management fees.

The solution

The best solutions tend to be personal and staged over time. It will engage and balance your family relationships with your own financial position and motivation to address the issue. From an adviser perspective, it is the most nuanced and interconnected area in which we advise. Leaving the issue unaddressed in lifetime creates problems which extend far beyond taxation. However, with careful planning, it is an enormously beneficial exercise for the whole family.

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