Introduction to estate planning
Between April and October 2024, IHT receipts reached £5.0 billion, a significant £0.5 billion increase compared to the same period the previous year. Factors driving this increase include:
- Rising property values, which push estates above IHT thresholds.
- The frozen IHT nil-rate band, which has remained at £325,000 since 2009. If adjusted for inflation (RPI), the nil-rate band would exceed £450,000.
Proactive estate planning is essential to mitigate the growing financial impact of IHT on families and their assets.
Normal Expenditure Out of Income
One way to reduce an estate’s taxable value is through gifts made under the “normal expenditure out of income” exemption. However, these gifts must meet strict criteria:
- Regularity: Gifts should form part of a habitual pattern, such as annual holiday expenses, education costs, or recurring premium payments.
- Income Origin: Gifts must be made out of the donor’s income, not accumulated capital. HMRC considers income to become capital after two years.
- Sustainability: Donors must retain sufficient income to maintain their standard of living.
Tip: Maintain detailed records to substantiate claims and avoid potential disputes with HMRC.
Residence Nil-Rate Band (RNRB)
Introduced in 2017, the RNRB offers additional IHT relief for individuals leaving their main residence to direct descendants.
Key Points and Pitfalls:
- The full allowance of £175,000 per individual is available only if the estate is valued at £2 million or less.
- Estates exceeding £2.35 million lose the RNRB entirely.
- Spouses with separate estates under £2 million each may lose the RNRB on the second death if planning is inadequate.
Planning Tip: Consider tenants-in-common ownership and leaving property to children on the first death to preserve the RNRB. Downsizing rules also apply but require meticulous record-keeping to trace the flow of funds.
Using the Rysaffe Principle to Reduce IHT
The Rysaffe Principle, established in Rysaffe Trustee Co v Inland Revenue Commissioners (2003), allows individuals to create multiple smaller trusts instead of one large trust.
Benefits:
- Each trust benefits from (almost) its own £325,000 nil-rate band.
- Periodic charges and exit charges are minimised, leading to significant savings.
For example, using 10 trusts could save nearly £195,000 in IHT.
Family Investment Companies (FICs)
Family Investment Companies provide a flexible alternative to trusts, offering control and adaptability.
Key Features:
- Structure: Parents often hold voting shares with limited capital rights, while growth shares are issued to children or trusts.
- Funding: Parents typically lend money to the FIC interest-free. These loans remain part of their estate but can be repaid or assigned as needed.
- Tax Efficiency: Accumulated income within trusts can cover future expenses such as school fees.
Changes to Business Relief (BR) and Agricultural Property Relief (APR)
From April 2026, significant changes will affect these reliefs:
- 100% relief will apply only to the first £1 million of combined APR and BR.
- Relief will reduce to 50% for values above £1 million with no transferable allowances to a surviving spouse.
- AIM shares will qualify for only 50% relief
Planning Window:
- Before April 2026, consider outright gifts of qualifying assets to children or setting up trusts to take full advantage of current unrestricted relief levels.
Inheritance Tax on Pensions
Starting April 2027, pensions will be subject to IHT, drastically impacting high-net-worth individuals.
Key Implications:
- IHT at 40% will apply to the pension pot.
- Beneficiaries face additional income tax when withdrawing funds, potentially leaving them with only 33% of the pension’s overall value.
Mitigation Strategies:
- Explore tax-friendly jurisdictions and Qualified Recognised Overseas Pension Schemes (QROPS) – but note there is now a 25% “exit charge” when exporting a pension fund
- Regular gifting of surplus income under the “normal expenditure” exemption can help reduce the taxable estate.
Employee Benefit Trusts (EBTs)
Many EBTs established in the 1990s and 2000s face unexpected IHT liabilities due to loans extracted by directors. Even when loans are repaid, HMRC may still levy charges based on their original face value.
Current Challenges:
- Ten-yearly IHT charges apply based on the original loan value.
- Exit charges may also arise when loans are written off.
A fresh review of the Loan Charge legislation has been promised, but businesses should prepare for potential liabilities.
Conclusion
Navigating the complexities of estate planning requires careful consideration of changing legislation and proactive strategies. Whether leveraging the RNRB, using the Rysaffe Principle, or exploring FICs, a tailored plan can significantly reduce IHT liabilities while preserving wealth for future generations.
Next Steps for estate planning
ETC Tax can ensure your estate planning aligns with your goals and remains compliant with evolving regulations. Please contact us if you would like more information or help with your estate planning
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