Inheritance tax (IHT) is chargeable on your estate if it exceeds the IHT nil rate threshold (currently £325,000). Effective inheritance tax planning can substantially reduce the amount of tax that will be payable on your estate. If your estate is likely to exceed the IHT nil rate band - at £325,000, this is less than the value of many properties - it's worth investigating how family trusts and other IHT planning options could benefit you.
Inheritance tax basics
Inheritance tax is charged at 40% on the value of your estate in excess of the nil rate band. The basic nil rate band is £325,000 (2020/21), but there is an additional residence nil rate band of up to £175,000 if you leave your home to a child or grandchild.
If your estate is valued at less than the nil rate band or meets the requirements for excepted estates, IHT is not payable. Equally IHT is not payable on any inheritance you leave to your spouse. In addition, if your own estate does not use up the full nil rate band, your spouse's tax free allowance will be proportionately increased.
You can reduce IHT by giving away up to £3,000 a year and small gifts to other people of up to £250 each tax free. Regular gifts out of income (but not capital) also reduce IHT, as do gifts to help maintain dependant relatives.
Larger gifts can avoid IHT provided you survive at least seven years after making the gift. To qualify, you must not continue to benefit from the assets you have given away.
Other IHT reliefs include reduced IHT on some business assets as well as gifts to charity. Death benefits from most pension schemes and life policies are exempt from IHT.
Family trusts and IHT
Family trusts can provide extra flexibility in your IHT planning. For example, a family trust can be used to provide a lifetime income for your spouse but with the assets passing to your children, or to help protect ownership of a family business.
The tax treatment of family trusts is complex and depends on the type of family trust being used. A 'bare trust' set up by a grandparent allows income and capital gains to be taxed as the recipient child's - often meaning that no tax is payable once the child's tax allowances are taken into account.
IHT may be payable on gifts into a family trust if the amount given exceeds the nil rate band. Income and capital gains made by the trust are also taxable.
Practical IHT planning
IHT planning, like other kinds of tax planning, should start with thinking about what you want, rather than simply minimising IHT. While gifts and family trusts can reduce the value of your estate (and so IHT), it's important to retain enough for your own financial needs.
The best IHT planning tends to be done early and takes a balanced approach to risk. A long-term view of IHT planning might include skipping a generation, for example, by setting up a family trust for future grandchildren.
Other practical issues include choosing the right trustees for any proposed family trusts, and organising your financial affairs so that your estate has ready access to the money needed to pay any IHT liability.
Reviewed by Nigel Merchant, Technical manager, Kings Court Trust
