WHY SHOULD YOU CARE ABOUT INHERITANCE TAX?
“WHEN I DIE AND AM BURIED, IT WON’T MATTER ANYMORE AND IT WON’T BE MY PROBLEM”
Approaches to Inheritance Tax (IHT) range from the laissez-faire, leave it to the children, attitude to the more proactive forward planning adopted by those families with significant inter-generational wealth. The majority of the UK population have traditionally ignored this tax as it only impacted high net worth individuals. However, post the financial crisis and quantitative easing, asset prices have been driven up and for the first time many are suddenly faced with the prospect of a significant inheritance tax bill as the nil rate band has hardly moved. In the tax year ending 2017, HMRC received £4.8 billion in IHT receipts compared to £2.4 billion for the tax year 2009-2010.[1]
Meanwhile the treasury recently announced a review of IHT as part of its tax simplification drive. However, simplification doesn’t necessarily mean lower IHT bills. What are the steps that you can take to minimise the impact of IHT?
- Spend down your wealth – but there is a limit to consumption spending.
- Give away your wealth – with life expectancy and the cost of care increasing, it’s difficult to gauge how much wealth you’ll need to maintain your lifestyle and fund social care.
- Self-insure – you can set aside a pool of funds to pay the inheritance tax bill but the trick is to grow the fund and protect it.
- Transfer the risk – this is by far the simplest, safest and cheapest solution provided you plan early.
So why are many people still resistant to IHT planning and life insurance?
- Ostrich mindset – Bury your head in the sand and hope it goes away.
- Pass the buck mindset – It’s not my problem to deal with; but is this fair to your children or other beneficiaries?
- Expensive mindset – many have the impression that life insurance is expensive but it’s surprisingly cheap compared to other planning options.
REALITY CHECK
Take some time to estimate the value of your assets and calculate your estimated IHT exposure; you may be surprised at the size of your potential IHT bill. Consider the following hypothetical example of a professional couple, in their sixties, living in London.
Potential IHT exposure on the second death:
| Savings and investments | £1.4m |
| London house | £2.0m |
| Less mortgage | -£400k |
| Other assets | £150 (art, jewellery and other collectables |
| Net estate | £3.15m |
| Less 2 nil rate bands | -£650k |
| No available residential nil rate band | -£0 |
| Total taxable estate | £2.5m @40% IHT bill of £1m |
On paper it looks like the estate has sufficient assets to pay for the IHT bill. However, this assumes that the assets can be sold at their current value. It’s often the case that your beneficiaries will receive less value in the event of a forced sale of an estate. In the absence of a crystal ball, there’s no guarantee that your death will not occur during the next financial crisis. So why run the risk?
The cost of a guaranteed whole of life on a joint life second death basis policy for a couple both in their sixties would be £13,826 annually[2]. That’s quite reasonable and equates to only 1.4% of the taxable estate. Additionally, it would be advisable to place the policy in trust to avoid the proceeds falling into the survivor’s estate and becoming subject to inheritance tax.
The beauty of life insurance is that it injects liquidity into your estate to pay the inheritance tax, thus giving your beneficiaries the luxury of time to enjoy the assets as they are or to sell them at a later date, when market conditions are ideal.
[2] Alternatively, if a couple anticipates a reduction in their potential IHT exposure by making future gifts, they may consider a reviewable whole of life policy as the rates are cheaper in the earlier years, but will become much more expensive than guaranteed whole of life in later years. For a couple in their sixties, the annual premium for a reviewable whole of life policy on a joint life second death basis would be £1,413 (fixed for the first ten years and then reviewed on the 10th anniversary and every 5 years thereafter).
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