Five ‘legitimate’ steps to take to avoid paying inheritance tax

Inheritance tax: Expert provides tips on avoiding hefty bill

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The figure for this year already looks set to breach that due to Chancellor Jeremy Hunt having frozen the inheritance tax thresholds for another six years in the Autumn Budget. The inheritance tax nil-rate band has been frozen at £325,000 since 2009, and it will remain at this level until 2028 with the residence nil-rate band also frozen at £175,000. With house prices continuing to rise combined with likely increases in other asset values, more and more estates are going to have to pay inheritance tax.

According to the Office for Budget Responsibility (OBR), inheritance tax collection is to reach £8.3billion by 2026.

Laith Khalaf, head of investment analysis at AJ Bell said: “Taxes don’t generally win popularity contests, but if there is one that gets people’s hackles up, inheritance tax is probably it.

“This is most likely because the time at which inheritance tax is levied is both upsetting and stressful because beneficiaries will almost certainly be grieving, and having to deal with a lot of administration and paperwork too.”

Inheritance tax is paid on the estate, the property, money and possessions, of someone who has died and is paid at a rate of 40 percent on anything over the nil rate band of £325,000.

Mr Khalaf added: “There are legitimate steps you can take to mitigate inheritance tax or avoid paying it altogether, though some of them are complex and potentially costly.”

Whatever way someone chooses to reduce their inheritance tax, Mr Khalaf explained how “the most important thing” was to make a plan in good time.

He said: “It can be a difficult subject to bring up, particularly for those who stand to be beneficiaries, so if you’re in the fortunate position of having a large pool of assets to pass on, it’s probably a good idea to start the conversation yourself.”

One of the “simplest” ways Mr Khalaf recommends is to gift assets to loved ones before someone dies.

However, he warned that if someone dies within seven years of making a gift, inheritance tax will actually be payable on a sliding scale.

He said: “There are some notable exemptions to this seven-year rule, however. In particular, everyone can gift up to £3,000 of their assets to beneficiaries each tax year without that sum becoming liable to inheritance tax, no matter when they die.

“A family wedding could be another occasion to consider passing some money on. Gifts of up to £5,000 to children made in advance of a wedding are protected from IHT, irrespective of when you die, and up to £2,500 for grandchildren.”

Mr Khalaf also noted that people can also be allowed to make gifts from their surplus income, provided they are regular and documented.

He added: “The rules around this form of gifting are complex, so it’s probably a good idea to seek the services of a qualified financial adviser if you are going down this route.”

Mr Khalaf noted how pensions or SIPPs (Self Invested Personal Pension) could also be a “useful tool” to pass wealth onto younger generations.

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He explained: “You can nominate beneficiaries for your pension in the event of your death, which must be officially submitted to your pension provider, and IHT is not generally payable.

“If you die after the age of 75 though, your beneficiaries will need to pay income tax on the money they take out of the pension.”

However, Mr Khalaf explained how the amount of income tax paid can be mitigated by withdrawing money from the SIPP gradually.

Setting up a trust can be another option someone could consider when thinking about passing on their wealth.

However, Mr Khalaf explained how trust can be a “complex area” which would definitely require a financial advisor.

He said: “The benefit is that whoever you appoint as the trustee can control the assets, rather than them being passed onto the beneficiaries right away.

“This might be useful if you are concerned about gifting assets to a loved one who is perhaps not renowned for their financial prudence, or perhaps to young grandchildren.

“Trusts can be expensive to run and subject to tax charges, which together with their complexity generally makes them worthwhile in only a few circumstances.”

Mr Khalaf also highlights how investing in some AIM shares can come with inheritance tax benefits, because many stocks on London’s junior market qualify for Business Property Relief.

Though someone must hold the shares for a minimum of two years before they are eligible for this inheritance tax exemption, and not all AIM shares qualify.

He said: “HMRC has published the rules which determine which sort of businesses qualify for this relief, but they don’t publish a definitive list unfortunately.

“So there is some risk of misinterpreting the rules here. You also shouldn’t invest in a company simply for tax purposes.

“If you make a poor investment it can end up costing you an awful lot more than 40 percent Inheritance Tax. If you don’t wish to select shares yourself, there are some professionally managed AIM portfolios available on the market, though they do tend to be quite expensive in terms of charges.”

Another option Mr Khalaf says people should consider is setting up an insurance policy which pays out when someone dies and thereby covers any inheritance tax liability.

He explained: “The policy should be written in trust, so the payout doesn’t fall into your estate and therefore be subjected to IHT itself.

“This route offers you peace of mind that your beneficiaries won’t struggle with a huge inheritance tax bill when you die, but you are effectively paying at least part of that bill while you are alive through your monthly premiums, which can be substantial.”

With an insurance policy, Mr Khalaf notes how if someone dies quite young, then they probably would get a good deal from the insurance policy, but if they live to a ripe old age, they won’t.

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