Pareto: What will your legacy look like?

  • Published on: 13/05/2024

Effective Inheritance Tax planning is a careful balancing act, essential for ensuring financial comfort in life and tax-efficient wealth transfer after death. With rising property values and unchanged tax thresholds, many families face significant IHT liabilities. Strategic planning, including prudent gifting and understanding tax implications, can help navigate these complexities and safeguard your estate.

Effective Inheritance Tax planning is a careful balancing act
Once a concern only for the very affluent, Inheritance Tax (IHT) is now an issue for many ordinary families, who may find themselves handing over an unprecedented portion of their estates upon death. This shift results from years of house price growth, inflation and stagnant tax thresholds. The Office for Budget Responsibility anticipates that IHT will bring in £7.2 billion in the fiscal year 2023/24[1].

Effective IHT planning is a careful balancing act. It’s about ensuring you can live comfortably and meet your care needs (if required) while also considering how to pass on your wealth in the most tax-efficient way. Navigating these complexities can be challenging, but it’s entirely manageable with open communication and careful planning.

Typically, IHT applies at a rate of 40% on the value of an estate above the ‘Nil Rate Band (NRB)’ allowance of £325,000 (which has been frozen until April 2028). This figure escalates to £500,000 if a primary residence is bequeathed to a direct descendant (ie, NRB of £325,000 plus the Residence Nil-Rate Band of £175,000). Assets passed to a spouse or registered civil partner are exempt from this tax.

Valuable reliefs and the seven-year rule
A variety of reliefs exist that enable families to protect more of their estate from IHT. The most significant of these is arguably the seven-year rule. This provision allows certain gifts to be tax-free, provided the giver survives for seven years after making the gift. However, this seemingly straightforward rule is fraught with potential pitfalls that could result in an unexpected bill from His Majesty’s Revenue & Customs (HMRC).

Estate planning is a complex endeavour. Prudent gifting requires sufficient funds to support a long life and cover care costs. Here, we explore the main tax traps that could cost you thousands and provide guidance on avoiding them.

Complications of gifting property
Often, the most valuable asset in an estate is the family home. However, the rules regarding property transfers are stringent. It is a widespread misunderstanding that transferring the legal ownership of a property to children while the parents continue to reside there will sidestep IHT. Such a transfer would be considered a ‘gift with reservation’ by the HMRC, as the original owner continues to benefit from the asset.

Avoiding the ‘gift with reservation’ pitfall
A parent wishing to transfer ownership but continue living in the family home would need to pay market rent to the new owner to avoid this situation. The HMRC would require a signed rental agreement specifying an annual rent review and evidence of payments.

Transferring ownership of your home while you continue to reside in it carries inherent risks, as you depend on the new owners not selling the property. Placing the property into a trust can help manage this risk, though this approach has its own costs and complexities.

Bestowing gifts and understanding the tax implications
Giving gifts can be a joyous act, but it’s crucial to understand the context when it comes to IHT. If you pass away within seven years of giving a gift, IHT may be charged on the amount exceeding the £325,000 allowance. This is based on a sliding scale and if death occurs within three years, the usual 40% rate applies on amounts above this allowance.

For gifts that potentially violate the seven-year rule, if the gift exceeds the available NRB Allowance, the recipient would be liable to pay tax. If this isn’t addressed, the deceased’s estate typically handles the tax, which can become complicated with multiple beneficiaries.

Tax-free allowances and their exceptions
Certain allowances are exempt from the seven-year rule. You can give up to £3,000 each tax year without it being considered part of your estate later. However, this allowance hasn’t changed for over four decades, and inflation has significantly diminished its value.

The annual allowance can be divided among several people or given to one individual, and unused allowance can be carried forward by one tax year. You can also give a tax-free gift of £5,000 to a child or stepchild for their wedding or registered civil partnership. For a grandchild or great-grandchild, it’s £2,500, and £1,000 for any other person.

Regular gifts from excess income
Regular gifts from your surplus income are exempt from tax, provided they don’t impact your standard of living. These gifts must come from your regular income rather than the sale proceeds of a property or other assets. They might include payments into a child’s savings account or to cover your child’s rent. HMRC closely monitors this relief, so it’s important to maintain detailed records of the amounts given.

Maximising your pension benefits
Pensions are one of the most tax-efficient benefits in life and after death. They usually don’t form part of your estate for IHT purposes, though this doesn’t apply to money already drawn from a retirement pot. However, there may be Income Tax to pay depending on when the donor dies and how the benefits are taken.

If you die after age 75, your beneficiaries will pay Income Tax on money taken out of the pension at their usual rate. Beneficiaries can potentially reduce Income Tax on inherited pensions by withdrawing money gradually, and this also depends on their overall level of income.

Role of trusts in planning
Trusts are versatile tools that play a significant role in estate planning. Individuals often opt to transfer gifts through trusts, which allows them to control the timing and purpose of the money’s accessibility. This method ensures that the beneficiary can only access the funds under specific conditions, at a predetermined time, or at the trustee’s discretion.

Moreover, life insurance policies can be integrated into an appropriate trust. This strategy ensures immediate access to funds for settling an IHT bill. Establishing a trust for your life insurance policy can provide a quick solution to potential IHT duties, preventing delays in the disbursement of the estate. It is worth noting that  trust are complex and advice should be sought first before making any decisions.

Power of Attorney is an essential tool in estate planning
Having a Power of Attorney in place is another crucial element of IHT planning and may require Court of Protection approval. It allows you to appoint someone you trust to make decisions on your behalf if you cannot do so. Knowing that your wishes will be respected even if you cannot express them personally can provide peace of mind.

Deprivation of assets and avoiding potential pitfalls
The term ‘deprivation of assets’ refers to deliberately disposing of property, assets or income to avoid care fees. If a local authority believes you’ve intentionally given away assets to evade these fees, they can charge you as if those assets were still part of your estate. Unlike the seven-year rule for gifts and IHT, there’s no time limit here – a local authority can investigate the disposal of assets going back decades.

To discuss any of the issues raised in this article, please contact Pareto. Further information can also be found at

The content in this article is for your general information and use only and is not intended to address your particular requirements.

Personal circumstances differ and not all of this information is applicable to every client and/or their business and should not be relied upon without seeking specific professional financial advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.

We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. All references to taxes and the allowances and reliefs are those available to UK tax payers.  The information in this document is therefore intended only for UK tax payers. The information provided is an overview of our understanding of the tax rules and guidance in place at the time of publication. Levels and bases of, and reliefs from, taxation are subject to change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested. Past performance is not a reliable indicator of future results. The Financial Conduct Authority does not regulate Tax Advice, Estate Planning, Trusts, or Will Writing.

Pareto Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.

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