Inheritance tax allowance freeze: How it could affect your estate planning

During the Budget, the Chancellor announced that the thresholds for paying Inheritance tax would be frozen for five years. It’s important to review your estate planning to reflect this and minimise the inheritance tax that may be due.

Have you considered inheritance tax (IHT) as part of your financial plan? It’s important you review your estate planning following allowance freezes in the recent Budget. Even if IHT is not something you’ve considered before, the freeze could mean you now need to.

On 3rd March 2021, Chancellor Rishi Sunak delivered the Budget. While tax increases affecting personal finances weren’t introduced, widespread freezes on allowances were. This means you could be worse off over the long term and so reviewing your financial plan, including your estate planning, is essential.

How does the Budget announcement affect IHT?

During the Budget, the Chancellor froze two allowances for IHT until 2026. As the allowances will not increase in line with inflation, some people could end up leaving their loved ones an unexpected IHT bill. The two allowances are:

1. The nil-rate band: The nil-rate band is £325,000. IHT may be due if the entire value of your estate, which includes all your assets, exceeds this amount.

2. The residence nil-rate band: If you’re leaving your main home to children or grandchildren, you can benefit from an additional £175,000 allowance.

It’s important to note that you can pass on any unused allowance to your spouse or civil partner. If you’re planning as a couple, it means you can leave £1 million without paying IHT. While this seems like a sizeable sum, once you start adding up the value of various assets, from property to investments, you could be closer to the threshold than you think.

The allowances were expected to increase in line with inflation. Instead, the freeze means that over the next five years you could move towards the threshold, or an expected IHT bill could be higher than anticipated.

While the value of your assets is likely to increase over the coming years, the unmoving allowances may mean your tax liability could increase. As a result, the move has been dubbed a “stealth tax”.

Currently, around 1 in 20 estates is liable for IHT, raising around £5.4 billion for the Treasury each year. It’s a figure that’s set to rise over the coming years as the freeze will push more estates over the allowance thresholds.[1]

With a standard rate of 40%, IHT can significantly reduce the amount you will leave behind for loved ones. Being proactive is key, so here are some steps you can take to reduce IHT.

5 ways you can reduce the IHT due on your estate

If your estate may be liable for IHT, there are often things you can do during your lifetime to reduce the eventual bill. Here are five steps to consider.

1. Spend some of your assets

The most obvious way to reduce an IHT bill is to spend some of your assets to fund your lifestyle. If you’ve been dreaming about a once in a lifetime trip or indulging in a hobby, this step presents an opportunity to turn these goals into a reality.

Keep in mind that this will reduce how much you leave behind for loved ones and taking money out of certain products could lead to a tax bill. Contact us if you have any questions.

2. Give gifts to loved ones

As well as improving your lifestyle, you may want to lend a helping hand to loved ones. Giving gifts can reduce your IHT liability and means family and friends can benefit from your generosity now. However, if you pass away within seven years of giving the gift, it may still be considered part of your estate for IHT purposes.

Making use of gifting allowances can form part of your plan to pass on wealth. Gifts that are considered immediately outside of your estate for IHT purposes include:

  • The annual exemption, which allows you to gift £3,000 each tax year
  • Gifts up to £250 to as many individuals as you want, although not the person that has benefited from your annual exemption
  • Wedding gifts to children (£5,000), grandchildren or great-grandchildren (£2,500), or another relative or friend (£1,000)
  • Gifts to helping with living costs, such as an elderly dependent or child in full-time education
  • Gifts from your surplus income, although you must be able to maintain your usual standard of living.

Some of the gifting allowances can be complex and it’s important you keep good records. If you would like to discuss how gifting can reduce your IHT liability, we’re here to help.

3. Use a trust to hold some of your assets

Placing some of your assets in a trust can mean they’re no longer considered part of your estate when calculating IHT. Depending on the type of trust used, you can still control the assets and receive an income from them. A trust is also a useful option if you’d like to leave some of your wealth to someone who cannot manage their own assets, such as children or a vulnerable adult.

Setting up a trust is complex and there is more than one type. Once a trust is set up it can be difficult or impossible to reverse, so it’s important you take both financial and legal advice.

4. Take out a life insurance policy

A life insurance policy won’t reduce an IHT bill, but it can provide the means to pay for it so that your estate remains intact to pass on to loved ones.

A life insurance policy will pay out a lump sum when you pass away. This provides your beneficiaries with a means to pay the IHT bill without needing to sell any of the assets left behind. You will need to pay regular premiums for a life insurance policy, which will vary depending on the level of cover you want and your health and lifestyle.

A life insurance policy intended to pay an IHT bill must be placed in a trust. Otherwise, it could increase the value of your estate and the amount of IHT due.

5. Leave a charitable legacy

Making donations to charities can reduce your IHT bill as well as doing good. There are two ways charitable donations can help.

First, they can reduce the overall value of your estate, potentially bringing it under the thresholds. Second, if you leave more than 10% of your entire estate to charitable causes in your will, the IHT rate will fall from 40% to 36%. In some cases, this will mean you leave more behind for family.

This option enables you to support the causes close to your heart, while making sense from a tax perspective too.

The above list isn’t exhaustive, and there are many other ways you could mitigate IHT and leave more behind for the people most important to you. Please contact us to discuss your concerns – we’re here to help you create estate planning that suits your circumstances and priorities.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

Foster Denovo Ltd is authorised and regulated by the Financial Conduct Authority

The Financial Conduct Authority does not regulate taxation and trust advice.