What is next for families and Inheritance Tax?

The landscape for Inheritance Tax (IHT) has changed, the new restrictions for Business and Agricultural property reliefs are now in place and on the horizon pension changes are looming. So what can families do now to protect their wealth?

The good news is that whilst there are restrictions, there are still opportunities to minimise tax and protect wealth for the next generation:

Good planning can only be done if you understand your exposure. Quantify your entire estate including your business, pension, property and investments. Then you can establish your IHT cost. Our IHT calculator can help you. Once you understand what your ‘number’ is then think about:

• Liquidity – do you have sufficient liquid assets in your estate to meet the liability without having to sell family assets
• Insurance – it is possible to insure against your IHT liability to fund a lump sum for your beneficiaries. This may also be useful for larger and more complex estates so beneficiaries can receive funds without waiting for probate.
• Business cash flow – if the value is in the business how can the liability be funded? Bear in mind it is possible to pay IHT liabilities relating to qualifying business assets over 10 years interest free. Can the business sustain this?
• Planning – there are still ways of mitigating your IHT exposure with careful use of gifting, IHT friendly structures such as trusts and family investment companies along with tax efficient investments.

100% relief is still available for assets with value of up to £2.5 million per individual. This means tax fee assets of up to £5 million for married couples or civil partners. This is not going to cover larger family businesses in full, but it does still present opportunities for succession planning:

• Shares with a value of up to £2.5 million per settlor can be transferred to trust without a tax liability.
• Get your business valued, this will help you establish how much you can or want to give away bearing in mind the tax-free limits and potential future growth. This should be measured against the fact that the proceeds of any possible sale would then be divided and required dividend income streams.
• Forgoing control is often an issue for family business owners, however a trust could mean that owners could start succession planning, while still retaining control of the business via the trust. It also starts to move value out of their estate.
• After seven years the £2.5 million is available again to the settlor in the same way as the IHT nil rate band, both for additional transfers or in the death estate.
• Think about family shareholders. Bringing in the next generation earlier than planned might seem daunting but can be incredibly valuable as part of their business and financial education. It also gives them skin in the game whilst saving IHT in your estate.

From April 2027 pension funds will form part of an individual’s estate on death. The rules are complex (Pensions Inheritance Tax | Crowe Financial Planning UK Limited )but broadly it means that the traditional plan of passing on your pension to the next generation as untouched as possible has changed. Formal advice should be taken from a pensions adviser if you decide to make pension withdrawals but broadly income strategies in retirement should be reconsidered:

• Consider cashflow forecasting to understand your income requirements on retirement.
• As part of your wealth planning, you can then establish the optimum ‘pot’ from which to draw your income.
• Traditionally pensions have been the last in line for income withdrawals now this should be reconsidered.
• For example; drawing income from a pension whilst chargeable to income tax will reduce the IHT chargeable on the remaining fund. Drawing tax free on a loan from say a family investment company is tax free but retaining value in an underlying asset that can be given away can be more efficient for IHT.
• Think about regular gifting, regular gifts out of income can be made to reduce your estate free from IHT as long as they do not affect your living requirements. These can be direct gifts or gifts into trust. You can supplement your income from your pension pot to increase this level of giving thereby reducing the remaining pot which would be subject to IHT.

Philanthropy is often high on the agenda for wealthy families but the impact of donations, particularly legacies, is often overlooked. Gifts to charity are not only tax free but can save tax in a number of ways:

• Gift aid – gifts out of income are automatically made with a 20% tax credit so for every £100 you donate, the charity can reclaim £25 from HMRC. Higher rate taxpayers can then claim additional tax relief up to their marginal rate on their tax returns.
• Gifts of assets – property and listed shares can be given to charity and tax relief is given against income for the market value of the asset given away. The value of these gifts is immediately removed for your death estate for IHT.
• Charitable foundations – often families who have the means would like to give back a bit more. This can be done by using managed charitable funds such as community foundations or organisations like the Charities Aid Foundation. Families can make donations that are managed by these organisations but directed to the causes of their choice. Again the donations qualify for tax relief.
• Family charity foundations – as a step further families can set up their own charitable foundations. These have to be carefully managed but are great way to involve the wider family in the management of the fund as part of their financial education.
• Legacy gifts – where over 10% of the net estate is donated to charity as part of a persons will then the rate of IHT on the estate is reduced from 40% to 36%. Often only small changes are needed to achieve this and the beneficiaries lose very little.  However, with the inclusion of people’s pension pots within the scope of inheritance tax from April 2027, those who have previously intended to rely on this relief should revisit their plans to check they are still suitable.

One of the most important parts to planning is communication and the documentation of your plans. Having a clear structure and plan for your wealth both in lifetime and beyond is important so that all involved parties know what your wishes are and what is expected of them. The areas highlighted are typically carried out by a legal team and can include:

• Wills – make sure you have an up to date will that does what you want it to. Circumstances and families change so your will should be reviewed regularly and certainly after any big financial or life events such as a business sale or marriage/divorce.
• Company shareholder agreements – these are important not just for the succession of business interests but for investment companies too, especially family investment companies that that hold significant wealth or assets. Understanding what you want the company to do in event of your death in terms of releasing funds or who you want to run the company can be included. They can also include rules for shareholders around permitted transfers to ensure the asset remains in the family.
• Pre and post nuptial arrangements – often the possibility of relationship breakdown can be a key reason why transferring assets to the next generation is delayed. A good legal team can make sure this is dealt with sensitively but robustly as part of the planning.
• Family charter – these documents combine a number of the issues highlighted and are used to ensure everyone involved is clear about how the family wealth is managed and distributed. It can help communication to interested parties at all levels and can give clarity in circumstances where emotions run high. 

Unsure where to begin? Speak to your usual contact at Crowe UK, or our Private Clients team, to start the conversation.