OK boomer, what is your inheritance tax strategy?
In the 17 years David Hartles has worked as a tax planner, the age of clients seeking professional estate tax advice has declined.
“Typically, it was people in their 70s and 80s who reached a stage where they were much more aware of their own mortality,” he says.
“Nowadays it’s often people in their 50s and 60s who know they’re going to have a problem in the future. However advisers are increasingly being contacted by children of wealthy people who think their parents should do more to plan for this – they don’t want to see 40% of their future inheritance go to HM Revenue & Customs.
Hartles is tight-lipped about his clientele, but he’s a partner at Shipleys – the accountancy firm known for advising big names in the entertainment industry.
However, the “inheritance issues” facing these household names are shared by a growing number of British families.
As the new tax year approaches, the Chancellor’s coffers have been swollen by the ‘tax brake’ as wages rise with inflation but income tax thresholds remain frozen.
Likewise, soaring house prices have pushed up the value of family properties – yet since 2009 the zero-interest bracket has remained solidly pegged at £325,000.
Married couples and people in civil partnerships can pool their benefits to earn £650,000, and the addition of the Zero Rate Residency Band (RNRB) in 2017 could boost up to £1m if you let the family home to your children.
These thresholds will also be frozen until 2026, when experts estimate that IHT’s annual revenue will be significantly higher than the £5.4bn raised in 2020-21.
If you’re reading this and thinking — blimey, I better check out any arrangements my parents might have made — Hartles has some advice.
First of all, don’t underestimate the sensitivity of this topic. Conversations about wills and inheritance are understandably difficult – no one wants to deal with their own mortality – and there is a risk that well-meaning concerns may come across as a dogged attempt to get more than your siblings. .
He suggests a conversation like, “I found this out and suggest you take some advice.” You may find that they already have.
Nevertheless, persuading older clients to face up to their potential IHT liabilities is also a problem for advisors.
Some tell me that putting a number on it – if you died today, that’s what your family would have to pay in inheritance tax – gets things moving.
“Having an indication of your future liability certainly focuses the mind,” says Rob Hodgson, wealth planner at Cazenove Capital.
Clients who have gone through the probate of their parent’s business are often surprised by the level of tax owed, as well as the administrative complexity involved.
“They don’t want their kids to have the same experience, so they want to take a staged approach and start having these conversations earlier,” he says.
One of the easiest ways to avoid inheritance tax is to make an outright gift (and then survive for seven years afterwards). Easy. Of course, the hardest part is knowing how much you can afford to give without running out of money yourself.
Hodgson often starts with a cash flow forecasting exercise, which helps clients better understand their financial situation and consider the impact of donating sooner.
“If and when donations were deemed appropriate, it’s obvious that customers like to see the next generation benefit from the money they’ve received,” he says.
Large gifts will be subject to the seven-year rule. It is possible to buy cover — called “estate tax insurance” — in the event that you die before the seven years have elapsed and the tax is due.
Sold through regulated financial professionals, the premium will reflect the age and health of whoever buys the policy, but could be cheaper than you think, as the tax liability decreases over the seven years.
However, the seven-year rule does not apply to donations made from surplus income (or from your annual donation allocations).
Hartles had clients who offered six-figure sums each year in this manner. He and other advisers say paying tuition for grandchildren is a popular way to use this tax break.
I recently met an FT reader at a conference who proudly informed me that he had decided to give his nieces, nephews and godchildren regular sums to pay their energy bills. “That way they can spend their own money on whatever they want,” he said.
However you give it away, you need to keep careful records to avoid leaving your loved ones with the nightmare of an HMRC investigation after your death.
When giving large gifts, Hartles suggests that clients write a formal letter to the recipient stating the amount offered and file their response accepting the gift.
In addition to documenting when the seven-year clock begins to tick, it should convince executors that your gift was not intended to be a loan. “A loan would still be part of your estate, but a gift might not,” he adds.
Another good habit is to print and file your bank statements so that donations (and your income level) can be proven if questions are asked later. “Some banks won’t give your executors seven years’ worth of statements — you’ll get six if you’re lucky,” he says.
Other methods of mitigating IHT are more expensive and complex – and the longer you leave it on, the more complicated it becomes.
Discretionary trusts give the settlor more control over who the money goes to and when, but married couples and civil partners are limited to placing up to £650,000 in trust (their combined zero-rate tranche) every seven years without immediate tax burden.
If there is less time left on the meter, using the commercial property relief rules – available on some (but not all) publicly traded stocks – is a popular route, as these only need to be held for two years to become exempt from the IHT. There is a whole industry of specialist managers offering “Inheritance Tax Isas” who invest in such companies – Isas being transferable to a spouse on first death, but entirely within the estate for IHT purposes.
People also use equity release to manage IHT liability – although this tends to be more common where a family home worth over £1m is the main or sole asset.
Of course, there are simpler solutions.
“With everything going on in the world around us, wealthy people increasingly feel that they have helped their children enough over the years and want to leave more of their wealth to charity than they have sustained throughout their lives, who are exempt from IHT,” says Hartles.
And another foolproof solution to IHT problems? Spend money. Our How to Spend It section is dedicated to helping you do just that.