It is often said that there are two certainties in life – death and taxes – but we can probably add a third– the fact that no one likes their money to go to the taxman!
In our webinar on expatriate financial planning and trusts (you can download the webinar and listen in full here), Infinity outlined five ways you can reduce your potential inheritance tax (IHT) liability in the UK.
Five Ways To Avoid Inheritance Tax Liability In The UK
1. Spend, spend, spend!
Her Majesty’s Revenue and Customs (HMRC) can’t tax what you don’t have, so spending your money will definitely require you to pay less inheritance tax before building up a substantial inheritance tax bill. The problem with this strategy is making sure you don’t run out of money before you die. Most people want to leave a large margin, and striking a balance between spending enough to avoid inheritance tax and keeping enough to remain financially secure to the end of your days is a very tricky thing to do.
2. Gift assets
Any transfer of assets that is not interspousal is classed as a Potentially Exempt Transfer (PET) and subject to the seven-year rule. There is no upper limit on the amount you can gift. If the gift giver dies within seven years of the gift, the amount falls back into the estate, and IHT is payable on a sliding scale. After seven years, no IHT is due on the gift.
The downside to gifting is that you lose access as the asset no longer belongs to you. It is possible to gift with reservation. One example would be gifting your house to your children while still living in it, but in this case, gift with reservation rules apply, and the property is still deemed to be an asset and therefore part of your estate.
The following gifts are exempt from inheritance tax:
- £3,000 per annum gift allowance (you can also use the previous year’s allowance if unused but can only go back one year)
- £250 small gift allowance to as many people as you want within a single year
- Gifting from excess income – an often-overlooked option for those who can afford to gift without it detrimentally impacting their standard of living. Gifts must be regular, which effectively means a gift should be given more than once.
3. Qualifying Non-UK Pension Scheme (QNUPS)
A Qualifying Non-UK Pension Scheme or QNUPS is a type of overseas pension scheme recognised by HMRC since 2010. It has enabled many expats to invest and save cash and assets that are not eligible for UK tax relief to create a nest egg for a comfortable retirement. As it is a pension, a QNUPS is exempt from IHT in the UK.
A QNUPS must be established while you are a non-UK resident and must be for retirement planning. There is no upper limit on contributions, but it must be evidenced at the outset that the money will be used to provide you with an income on retirement.
4. Establish a trust
The main things to consider when establishing a trust are access, control and income. Below are three specific types of trust which are often used by British expats, along with a brief outline of their main features.
- The settlor gifts and gives up all access to the funds
- Any growth in the assets in the trust is outside of the estate from day one
- The entire portfolio is outside the estate after seven years
- With an absolute trust (where the beneficiaries are named in absolute entitlement), the gift is considered a Potentially Exempt Transfer with no upper limit and subject to the seven-year rule, i.e. no IHT due after seven years, IHT due on a sliding scale in the interim
- With a discretionary trust (beneficiaries are at the discretion of the trustees), the gift becomes a chargeable lifetime transfer (CLT) and is added to other CLTs and subject to IHT above the Nil Rate Band of £325,000
Discounted gift trust
- An extension to a gift trust
- This type of trust allows the settlor to make a gift (not subject to IHT) while retaining an income for life or until fund depletion
- There are some immediate IHT savings from the discount on the estimated value of the future retained payments
- Income is fixed and cannot be changed
- Example: Jane puts £100k into a discounted gift trust with an income of 4%, so she receives £4,000 per year. The provider segments that part of the trust, e.g. Jane will survive for ten years and receive a total of £40,000. This amount is outside of Jane’s estate from day one. The £4,000 p.a. income received by Jane is fixed and cannot be changed at any point.
- A discounted gift trust is a useful tool for those approaching retirement and wanting to take an income while reducing IHT liability
Excluded Property Trust
- The settlor must be non-UK domiciled when the trust is set up
- Assets must be non-UK, i.e. offshore investments, property etc.
- The settlor can also be a beneficiary and retains access to the funds, even if they become UK domiciled in the future
Obviously, these are just broad brushstrokes outlining the types of trust available to expats in Asia, and there are many more trusts, such as a lifetime interest trust, to explore. If you would like to know whether a trust could be a useful estate planning tool for you, it is essential that you consult a professional who will take a careful look at your personal circumstances. Our team of financial consultants have a wealth of experience and would love to hear from you.
5. Whole of Life Insurance
This scenario is when an individual accepts that they will have to pay inheritance tax on their estate and takes out insurance to pay it. The premiums will be less than the inheritance tax. Whole of life insurance is used widely as an estate planning tool. Speak to your financial adviser to discuss your options.
Inheritance tax solutions do not work overnight, and estate planning takes time. It’s worth taking advice early to start the process and ensure that you have the right tools in place to get to where you want to be.
To give you an idea of how effective trusts can be as a tool to avoid inheritance tax liability, we have put together a couple of interesting case studies. Click on the links below to check them out:
To find out how one British expat couple reduced their IHT liability from £200k to £26k using a joint discounted gift trust, click here.
To find out how one British/Malaysian couple reduced their IHT liability from £140,000 to zero using an excluded property trust and a QNUPS, click here.
Q&A On Ways to Avoid Paying Inheritance Tax in the UK
What is the inheritance tax rate in the UK?
The inheritance tax rate is currently 40% in the UK, applicable to any taxable estate in the case of death. The values of estates may be reduced in certain circumstances as a result of tax-free allowances, like the Residential Nil Rate Band and the Nil Rate Band, along with reliefs and exemptions.
If you donate a minimum of 10% of your net estate to charity, you can effectively reduce your inheritance tax rate from 40% to 36%.
What is the inheritance tax threshold?
The inheritance tax threshold is also called to Nil Rate Band. It is a tax-free threshold for each person in the UK. Currently, the Nil Rate Bank lies at £325,000, and transfers of estates during a person’s lifetime as well as estates on death are subject to this threshold. If someone dies without using their entire Nil Rate Band, the remainder can be passed to their surviving spouse or civil partner.
This specific inheritance tax allowance effectively decreases your estate’s worth as a means to avoid inheritance tax on the first £325,000 of your estate’s assets. Since 2009, the Nil Rate Band has stayed the same, and since 2016, it has been frozen. This means you are likely to be liable for inheritance tax on your estate every year.
The relationship between inheritance tax and capital gains tax?
If you use gifts as a means to avoid inheritance tax, it is worth noting that particular asset transfers will involve capital gains tax when you are still alive. You could find yourself in a difficult situation if you make gifts as a means of avoiding inheritance tax only to have it be subject to capital gains tax.
What is Capital Gains Tax?
Capital gains tax is the tax chargeable on the disposal or sale of assets that are non-exempt. This tax often applies to valuables, investments, and property rent but not to your main residence.
Regarding inheritance tax gifts, you could dispose of valuable assets, like a rental property. If the asset isn’t sold for a market value, the gift’s value will probably be assessed for capital gains tax. In a tax year, the first £12,000 of a person’s capital gains will be tax-exempt. Beyond that amount, the capital gains are added to your income for the relevant tax year.
Capital gains that fall within the basic rate income tax threshold are taxed as follows: property is taxed at 18%, and any other capital gains are taxed at 10%. Capital gains beyond the higher rate income tax threshold will be taxed as follows: Property is taxed at 18%, and any other capital gains are taxed at 20%.
What is inheritance tax insurance?
You can set up inheritance tax insurance to provide a lump sum payout when you die. Therefore, it is effectively a whole of life insurance policy. You can then use this whole of life insurance policy to pay your inheritance tax liability rather than avoid inheritance tax liability.
Other types of life insurance can also be used for inheritance tax purposes, including term assurance. This approach does not come without its risks, though. The threat is that term assurance will run out after a certain amount of time has passed. If you outlive the term, you may be unable to afford or set up a new policy.
Whole of life insurance will always pay out the assured amount if you keep up with the cover’s cost during the policy’s lifetime. Therefore, the cost will keep increasing the longer you stay alive. Therefore, it may become very expensive if your inheritance tax insurance begins when you are older.
Essentially, you are responsible for paying the inheritance tax insurance when you are alive so that your family will receive a lump sum when you die to cover the inheritance tax liability.
Do I have to pay tax on the money I give to my spouse or civil partner?
Money paid to your spouse or civil partner is exempt from inheritance tax and thus serves as a means to avoid inheritance tax.
What is involved in calculating an inheritance tax bill?
To calculate an inheritance tax bill, all the assets of the deceased, including what was owed to them, must be added together, and their debt deducted from the total.
The inheritance tax is then deducted from the calculated amount. If the deceased received their spouse or civil partner’s residual allowance, including additional residential allowance, it must be included in this calculation. Any gifts the deceased made in the previous seven years are also considered.
Can discounted gifts be used to reduce inheritance tax?
Discounted gifts give individuals the opportunity to make gifts money to a trust and generate an income from the trust. The purchase of the trust serves as an investment bond, and this investment can be used to generate an income. The assets in the trust are not considered part of your estate and can therefore serve to reduce your potential inheritance tax bill.
What reliefs and exemptions are there on inheritance tax?
You might be subject to taper relief if you gave a gift within the preceding seven years before death. This taper relief will reduce inheritance tax to less than 40%.
Furthermore, particular assets may be subject to business property relief and agricultural relief. If this relief applies to you, seek advice from an independent financial adviser on how much inheritance tax you will need to pay.
What will the inheritance tax threshold be if you leave your estate to direct descendants?
Your inheritance tax threshold may be up to £500,000 if you pass your assets to your direct descendants, which includes your children, stepchildren, adopted children, or foster children. If you are in a civil partnership or married, and your estate’s worth is less than the threshold when passed on to your spouse or civil partner, their threshold may be up to a million pounds when they pass away.
What is the annual exemption?
You are allowed to give away an amount of up to £3,000 in a given tax year without having to pay inheritance tax. You could use this amount for one year if you didn’t use this allowance in the previous tax year, effectively doubling the allowance to £6,000. Furthermore, if you are married, you can give away a combined amount of £12,000 in a given tax year.
What are potentially exempt transfers?
If a lifetime gift is not exempt from inheritance tax, it is referred to as a potentially exempt transfer, or a PET, which is a powerful inheritance tax planning tool. Typically, no tax has to be paid on the same day a gift is made if a lifetime gift is subject to inheritance tax. Potentially exempt transfers are one of the ways to avoid paying inheritance tax as it reduces your estate’s value. If you find a way to justify many potentially exempt transfers and you live long enough, you can effectively reduce your inheritance tax substantially or even avoid paying inheritance tax all together.
Who pays inheritance tax?
Inheritance tax is payable in the UK by UK residents on the deceased’s estate, as well as on UK property of a UK resident who lives abroad. Such property includes cash, real estate, possessions, and investments. The inheritance tax is calculated according to the net value of the entire estate along with all lifetime gifts that were made in the seven years preceding the person’s death.
How much is the residence nil rate band, and who is eligible for it?
The threshold becomes higher when a person leaves their family home to their direct descendants. This threshold can be transferred between civil partners and spouses and is currently £175,000.
This threshold only applies to you if your main residence is passed to your direct descendants. Taper relief may apply to you, so inheritance tax is decreased by one pound for every additional two pounds if the estate’s worth more than £2 million.
Which gifts are exempt from inheritance tax charges?
Tax-free gifts to spouses
Anything a person gives to their spouse or civil partner on their death and during their entire lifetime is free from inheritance tax. Inheritance tax may still be payable if the spouse dies, but tax-free gifts are still a helpful way to avoid inheritance tax, especially when a spouse or civil partner is younger than the other.
You can give away up to £3,000 in a given tax year without having to pay inheritance tax. You could bring your personal allowance forward one year if you did not use it in the previous tax year.
You are permitted to give away £250 to as many people as you want, however many times you want. Thus, small gifts are essentially unlimited gifts where you don’t have to worry about how much tax you will have to pay.
There are certain rules that apply to gift-giving to children or grandchildren when they get married, of which some amounts are considered tax-free gifts, not being subject to inheritance tax.
Gifts to charities and political parties
You can gift charities and political parties with as much money as you want and avoid inheritance tax while doing so. If charitable donations are included in your will, the inheritance tax charged on your estate is reduced to 36%. These gifts must make up 10% of your net estate to qualify for being excluded from your IHT bill.
Which assets are included in your estate?
Anything that has value should typically be included in your estate for the purpose of inheritance tax. In the case of jointly owned assets, only your shares of the assets must be included in your estate. The following assets must be included in your estate, although there are many other assets not included in this list.
- Bank accounts
- Business assets
- Antiques and jewellery
- Gifts made in the seven years preceding death
- Life assurance that is not held in trust
The total value of a person’s estate must be taken on the date of the person’s death. Certain assets may require special valuations.
Disclaimer: Please note that this post is for information only. Trusts and inheritance tax planning are complex subjects with no one-size-fits-all solution. You should always seek professional advice from a qualified professional before making important financial decisions.
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