How to plan for the legacy you want

Figures out recently show that the government collected 35 per cent more of this tax between April and August 2021 compared with the same period the year before. 

While this tax is a £2.7 billion windfall for Rishi Sunak, it can eat away at the money we hope to give to the next generation.

Here are five ways to minimise the effect of the tax on our family’s wealth.

Understand the scale of it

Not everyone’s estate is liable for IHT. It is levied at 40 per cent on any part of your estate over a threshold called the ‘nil rate band’ (currently £325,000) but there are some other exemptions that can ensure that your family pays less.

One of these is the additional Inheritance Tax-free allowance for those who are passing on a property that they lived in during their lifetime. Each person has a £175,000 allowance for this, as long as their estate is under a certain amount, meaning that they can pass on £500,000 in total without paying IHT as long as the property goes to a direct descendant.

On top of this a surviving spouse or civil partner can ‘inherit’ their partner’s IHT allowances, meaning a total of £1m of assets can be passed down in some cases.

By looking at these calculations you should be able to work out whether your total estate is likely to have an IHT issue, which will help you to know what to do about it.

Start thinking early

The rules around IHT are complex and many of the ways to minimise it should be years in the planning. For example, if you want gifts you give to family to be free of inheritance tax you generally have to survive seven years after giving them, which could mean some careful balancing on your part.

Talking to family and to a financial adviser about your legacy planning as early as possible can help with this. At the same time, setting up a financial and health power of attorney and making or updating a Will, will ensure that your affairs are taken care of at a stressful time.

Use the gift allowances

The rules and reliefs that are most beneficial to you when it comes to IHT depend on your personal and financial situation. The advice you receive will be different based on whether you’re single or married, if you have children or grandchildren, if you own your own business, or on many other factors.

Most people could benefit from using the gifting allowances, however. These allow you to give away a certain amount of money in certain circumstances, free of tax. Here are some of the most useful ones.

  • Small gifts (up to £250) to different individuals are typically free from Inheritance Tax. This rule is intended to cover any birthday gifts, Christmas gifts, etc.
  • Larger gifts are free from Inheritance Tax up to a total of £3,000 in each tax year. If you don’t use your total allowance in one tax year, you can carry it forward to the next year as long as you also use up the current year allowance.
  • Wedding (or registered civil partnership) gifts are free from Inheritance Tax up to a certain value, which depends on your relationship to the recipient. If you are their parent, the limit is £5,000. If you are a grandparent or great grandparent, the limit is £2,500. In any other case, the limit is £1,000.
  • Regular gifts out of income – unlimited amounts as long as made regularly out of surplus income such that standard of living isn’t affected. Ensure that you keep very careful records of these types of gift, as HMRC may check this later on.

Use the best weapon in your arsenal

Aside from the nil rate bands, your best way to ensure that family does not pay IHT on what you are leaving them is to bequeath them your pension. This stands outside your estate for IHT purposes so can be gifted direct. It may make sense to leave pension assets untouched for as long as possible because of this, as well as making sure the beneficiaries on your pension and your will are up to date.

Plan your cashflow

No-one knows how long they will need their money for, which makes planning for IHT very difficult. But cashflow forecasts can help you to understand how much money you will need for yourself each year, and how much you can give away and when.

A financial adviser should be able to help you with these calculations, as well as with the best ways to finance retirement, hopefully leaving an inheritance to the children along the way.