How can I minimize inheritance tax on my estate?
I have a concerning and unfair Inheritance Tax (IHT) situation. I’m 90 and my daughter has given up a decent job to take care of me. I live in a house valued at around £1million, I own shares worth c. £1.6 million and have cash and bonds worth £400,000. My solicitor said the house should be passed on tax free but my investments would be taxed at their value less £325,000 times 40%.
Currently I give £1,500 in total from my income each month to my two children. Brokers and lawyers told me not to transfer my company pension – that was the wrong thing to do. In hindsight, I should have put everything into a self-invested personal pension (Sipp).
I owe everything to my daughter who does so much for me and I don’t want her to pay so much tax. Can you help me to solve this riddle. I believe Australians do not pay inheritance tax.
Julia Rosenbloom, Tax Partner at Tilney Smith & Williamson, responds:
Your question illustrates the complexity of IHT laws.
IHT is generally payable at a rate of 40% on the value of an individual’s estate on death, although this is subject to a number of rules which may reduce the amount payable.
If an estate passes to a spouse or civil partner, IHT is generally not payable. It is essentially deferred until the death of the survivor and passes the assets to other family members. You don’t say if you have a surviving spouse, but I assumed you were widowed. In this case, you may have your own ‘zero rate tranche’ of £325,000 which you can deduct from your estate, plus up to an additional £325,000 in respect of your deceased spouse, if the latter left the their entire estate to you upon their death (the “zero-rate transferable portion”). This could mean that up to £650,000 of your £3m estate is subject to 0% IHT, with only the balance of £2.35m being taxed at 40%: an IHT liability of 940,000 £.
An exception would be if you or your spouse made donations in the seven years prior to your death. In this case, the value of these gifts would be deducted from the combined zero rate bracket. You talk about monthly income donations. There is a specific exemption which means that these regular gifts must not encroach on the nil tranche, even if they are made within the seven years preceding the death, provided that these regular gifts leave the donor with sufficient income to finance the expenses of subsistence.
As for the home, the solicitor may have thought of the ‘zero-rate residency band’, which can potentially grant spouses an additional £350,000 exemption when primary residence passes to children. However, this is not available on domains of this size as it is phased out once a domain reaches the value of £2m.
Your comment on Australian tax law made me wonder if you are perhaps an Australian living in the UK? If so, you may not be domiciled in the UK (non-dom). Non-doms are generally only subject to UK IHT on their UK assets – their overseas assets are not affected. It looks like your estate consists of only UK assets in any case. But even if you hold assets outside the UK, if you have resided in the UK for at least 15 of the last 20 tax years, you are considered to be domiciled in the UK and your “Australian origin” does not matter. no IHT relevance. If you have been resident in the UK for less time you should take further advice as it may be possible to reduce exposure to IHT.
The other point to be addressed concerns pensions. It is correct that pensions are, for the most part, outside the scope of the IHT, so using non-retirement wealth to fund living expenses can be beneficial. However, you shouldn’t feel too bad as there is only a limited amount that can be contributed and held in most pensions without incurring tax charges. There are also limits on the assets that can be held by pensions.
If you want to mitigate the IHT, you can consider donating now, either in cash or in investments (careful consideration is required before donating the house). If you were to die within seven years of the donation, the beneficiary would be liable for IHT, so your age will need to be taken into account. However, if you survive at least three years, the rate of IHT payable on the donation decreases, depending on the length of survival. For example, if you survive between three and four years, the IHT would only be payable at a rate of 32% on the value of the donation, rather than the inevitable 40% if no donation is made. The rate then reduces to 24%, 16%, and 8% for four-year, five-year, and six-year survival, respectively. Note that if a given asset is at a gain, capital gains tax may be payable, so professional advice should be taken. You’ll also need to make sure you keep enough to fund your living expenses, as any gift must be “unconditional” to be effective.
You can also consider investing in assets that are exempt from IHT, such as shares listed on the Alternative Investment Market (Aim). Once these shares have been held for two years, they are eligible for commercial property relief, which may exempt them from IHT. However, these investments tend to be riskier, so you should seek professional advice before investing in them.