Boy on father's shoulders

Welcome to part two of our four-part series on preparing for Inheritance Tax (IHT), providing guidance on how you can mitigate the effect it has on your estate.

Last week, we looked at the issue from a financial planning perspective, considering the ways you can structure your wealth to reduce your Inheritance Tax liability. This week we’ll be addressing the personal legal aspects of Inheritance Tax and showing you the instruments that are available to you to help you plan effectively for transferring your estate to the next generations of your family.

A Trusted Solution

In last week’s article on the financial planning issues around Inheritance Tax, we looked at how gifting money to younger generations of your family can help to reduce your IHT liability. However, in some instances, depending on the age of the beneficiaries, the donor may feel that they are not yet old enough to use the money wisely or in a way that the donor would prefer.

A useful solution to this is to use a trust. A trust can enable money to be transferred across family generations but allows the donor (as a trustee) to retain control over how it is spent. The funds can be retained until the trustees are happy it is the right time to distribute them.

Everyone is allowed to put a maximum of £325,000 every seven years into a trust, free of Inheritance Tax. A married couple would be able to deposit £650,000 in a trust over the same time frame. As long as the person giving the money away cannot benefit from the trust, it works for IHT mitigation purposes and is the most straightforward way of using a trust to reduce the value of your estate.

It is worth bearing in mind that sometimes this option doesn’t work well for younger parents looking to set up a trust for their children. If the children are under 18 years of age, the parents will pay tax on anything that is paid out to the children. For example, if parents set up a trust to pay for their children’s school fees, when the funds come out of the trust to pay the fees it is considered as income, which the parents will pay Income Tax on at the normal level. However, this doesn’t apply to grandparents. If they were to set up a trust for their grandchildren’s school fees, this would not attract Income Tax and is therefore a useful way of reducing the Inheritance Tax liability of their estate.

Using a Trust in your Will

When deciding how to structure a will, it’s common, particularly in the case of married couples, for them to ask that when one of them dies everything should go to the surviving spouse. Then when the second spouse dies, they would request that everything passes outright to their children. From an Inheritance Tax-planning perspective, this works effectively on the first death as everything that passes to the surviving spouse does so free of IHT. However, on the second death, if everything goes outright to the children that then increases the value of their own estates for Inheritance Tax purposes.

A more effective option is to set up a trust for the estate to pass into on the death of the second spouse. The beneficiaries of the trust would be the surviving children. This allows the children to benefit from the funds in the trust without the value being counted in their estate for IHT purposes. If they have children of their own (who would be the grandchildren of the original couple), the estate, held in trust, can also pass on to them free of Inheritance Tax liability.

Family Investment Companies

Family investment companies (FICs) have also become a popular option in recent years for those looking to reduce their Inheritance Tax liability. While there is a limit to the amounts you can put into a trust to avoid IHT (as noted above, no more than £325k every seven years), there is no limit to the amount you can put into a company. This is a particularly attractive option as tax rates for companies are getting lower – corporation tax rates are coming down to 17% in 2020 – while the highest rate of personal Income Tax remains at 45%.

So how do family investment companies help you to mitigate the effects of Inheritance Tax on your estate? Firstly, you would set up the company and transfer funds into it, usually by way of a loan. You would then subscribe for voting shares in the company, meaning you would take a controlling stake. Then, you would also subscribe for other classes of shares in the company which you are allowed to give away to family members free of IHT liability.

By gifting the shares to family members or to a family trust in this way you can reduce the value of your estate for Inheritance Tax purposes. (Business owners: later in this series we will be looking at how you can use trusts to mitigate Inheritance Tax when selling or passing on a business – stay tuned!).

Final Thoughts

If you would like some help or advice with your Inheritance Tax planning, whether it be for private legal matters or any other aspect of IHT planning, please get in touch. Progeny’s unique structure allows us to provide expert legal and financial advice that delivers holistic solutions to your estate planning challenges, unlike other firms which deal with the issues in silos. We’d love to talk to you about how you can most effectively pass your wealth to the next generations of your family.

In part three of Progeny’s Guide to Inheritance Tax Planning, we consider the issue from an asset management perspective and explain how investors can take advantage of the Alternative Investment Market (AIM) to reduce their Inheritance Tax liability. Click here to continue reading!

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Author John Brien

Senior Adviser, Progeny Private Law

John has significant experience of advising clients on tax and succession planning.

Learn more about John Brien

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