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How can I minimise inheritance tax on my estate?

A reader is concerned that IHT may impact his ability to repay his daughter a debt of gratitude
How can I minimise inheritance tax on my estate?

I have a worrying and unfair situation regarding inheritance tax (IHT). I am 90 and my daughter has given up a decent job to look after me. I live in a house valued at around £1mn, I hold equities worth c. £1.6mn and have cash and bonds worth £400,000. My solicitor said the house should pass down tax free, but that my investments would be taxed at their value less £325,000, times 40 per cent.

Currently I give £1,500 in total out of income each month to my two children. I have been told by brokers and solicitors not to transfer out of my company pension scheme, that it was the wrong thing to do. With hindsight I should have put everything into a self invested personal pension (Sipp).

I owe everything to my daughter who does so much for me and I do not want her to pay such an amount of tax. Can you help me solve this conundrum. I believe Australians pay no inheritance tax. IW


Julia Rosenbloom, tax partner at Tilney Smith & Williamson, replies:

Your question illustrates the complexity of the IHT laws.

IHT is generally payable at a rate of 40 per cent on the value of an individual’s estate when they die, although this is subject to a number of rules which may reduce the amount payable.

If an estate passes to a spouse or civil partner, IHT is generally not payable. It is essentially deferred until the survivor dies and passes assets to other family members. You do not say whether you have a surviving spouse but I have assumed you are a widow(er). In this case, it is possible that you have your own nil-rate band of £325,000 which you can offset against your estate, plus up to a further £325,000 relating to your deceased spouse, if the latter left their entire estate to you when they died (the 'transferable nil-rate band'). This could mean up to £650,000 of your £3mn estate is subject to a 0 per cent IHT rate, with only the balance of £2.35mn being taxed at 40 per cent: an IHT liability of £940,000.

An exception would be if you or your spouse made gifts within the seven years before death. In that case, the value of those gifts would be deducted from the combined nil rate band. You refer to monthly gifts out of income. There is a specific exemption which means those regular gifts should not eat into the nil rate band, even if made within the seven years before death, provided that those regular gifts leave the donor with sufficient income to fund living costs.

As regards to the house, the solicitor may have been thinking of the “residence nil rate band”, which can potentially give spouses a further £350,000 exemption where the main residence passes to children. However, this is not available on estates of this size as it is gradually withdrawn once an estate reaches the value of £2mn.

Your comment about Australian tax law made me wonder if you perhaps are an Australian living in the UK?  If so, you might be non-UK domiciled. Non-doms are generally only subject to UK IHT on their UK assets – their overseas assets are outside the scope of this. It seems that your estate consists only of UK assets in any case. But even if you hold assets outside the UK, if you have been resident in the UK in at least 15 of the ast 20 tax years, you are deemed UK domiciled and your Australian background has no IHT relevance. If you have been UK resident for less time, you should take further advice as it may be possible to reduce the IHT exposure.

The other point to address is around pensions. It is correct that pensions are, for the most part, outside the scope of IHT, so using non-pension wealth to fund living expenses can be beneficial.  However, you should not feel too bad as there is only a limited amount that can be contributed to and held within most pensions without incurring pension tax charges. There are also limitations on what assets can be held by pensions.

If you want to mitigate the IHT, you could consider making some gifts now, of cash or investments (extra care is required before gifting the house). If you were to die within seven years of the gift, the recipient would be liable to IHT so your age will need to be taken into account. However, if you survive at least three years, the rate of IHT payable on the gift reduces, depending on the length of survival. For example, if you survive between three and four years, IHT would only be payable at a rate of 32 per cent on the value of the gift, rather than the inevitable 40 per cent if no gift is made. The rate then reduces to 24 per cent, 16 per cent and 8 per cent for four-year, five-year and six-year survival, respectively. Note that if a gifted asset is standing at a gain, capital gains tax may be payable, so professional advice should be taken. You would also need to make sure you keep enough to fund living expenses as any gifts need to be “without strings” to be effective.

You could also consider investing in IHT-exempt assets, such as shares listed on the Alternative Investment Market (Aim). Once such shares have been held for two years, they can qualify for Business Property Relief, which can exempt them from IHT. However, such investments tend to be higher risk so you should get professional advice before investing in them.