INHERITANCE TAX PLANNING: 10 STRATEGIES YOU CAN FOLLOW
Reviewed by:
Junaid Usman Date Published: March 11, 2021
UK and Int’l. Business Tax Consultant Last Modified Date: March 15, 2021
You might have mostly heard this frequently asked question, “Where you see yourself in the next five to ten years?” and people have a long list of goals to deliver. But what if you don’t even have a chance to live for the next years. What are your strategies then because life is too much uncertain? You will be concerned for your family. Inheritance tax planning will help you for future planning.
You will try to secure their position first by making a lot of money to pass on them. It is a well-known fact that taxes are a must thing in this world and everyone pays it on a daily basis. The money you have made implies under the same condition. In simple words, your direct descendants have to pay inheritance tax.
“What if you don’t even have a chance to live for next years? What are your strategies then because life is to much uncertain.”
The inheritance tax will increase with an increment in the number of assets or money left behind. So your basic concern is how to limit your specified inheritance tax. In this brief article, we will be sharing different tricks through which you could reduce your inheritance tax liability by inheritance tax planning and maximize the transfer of wealth to the next generation.
So let’s just jump into different strategies that help you to avoid inheritance tax by considering inheritance tax planning.
Strategies No. 1: Purchase Discount Gift Trusts
The first strategy that you can adopt is “DISCOUNTED GIFT TRUST.” Now, what does that mean? A discounted gift trust is a bit of legal paperwork setting up trust around an offshore investment bond that can hold global assets. This term specifies a fixed annual payment back to the settlor.
Like, if you invested a particular amount into this offshore trust, a total of 5%of the initial settlement could be paid back to you per annum for almost 20 years. So, investment bonds have a 5% withdrawal allowance with zero percent income tax to pay. This means if you can easily withdraw 5% of your investment from an investment bond without paying a single penny.
To make it simple, let’s suppose a settlor or you pays £500,000 into CGT. CGT specifies 5% payment per annum back to the settlor, which comes out to be £25000. The Discount follows the value of the future cash flow, which is calculated to be £357,000 and falls immediately outside the settlor’s estate, making an instant inheritance tax-IHT saving of 40% that comes out to be £142,800.
The gift term follows that £500,000 minus £357,000 is £143,000 which is below nil rate band of £325,000. So, now inheritance tax is liable to your investment or cashback. If the settlor lives for another 7 years, the IHT liability falls to zero allowing the settlor to avoid inheritance tax easily.
£ 500,000 ..………………… Total Cash
(375,000) ..……………….. Gift
£ 143,000 ..………………… Amount Subject to IHT
* 0.40 ..………………… IHT Rate
[ £ 57,200 ] …………………… Amount to be paid to HMRC
But by simply converting this money into CGT and receiving cashback of 5 percent, this tax can be avoided. Discounted Gift trust can be used for individuals with sizeable estates that want an immediate reduction in inheritance tax liability. It’s a no-cost effective method that could be adopted
Strategies No. 2: Avail Loan Trust
Another strategy that can be adapted to use the inheritance nil rate band in your favor is “LOAN TRUST.” In this strategy, the client lends monies to trustees, and trustees invest in a life company bond. This loan is repayable on demand with no interest on death. A client can receive back the original investment from the trustee in lump sum form, by using a 5% tax-deferred allowance or by a combination of both.
The original loan is not inheritance tax efficient remains in the state as no gift made, but the growth on the investment outside the estate from day one. This freezes the client’s liability on investments to the loan. This mechanism is often referred to as asset freezing.
Let’s suppose that a person is of age 50, and we expect his life to be 34 more years meaning up to 80 years. The 5% tax-deferred tax allowance per annum would simply mean an 80% return of money without any tax. This method could be adopted to make some specific assets free from inheritance tax.
Importantly, a loan of any value can be made to a discretionary loan trust without a charge per lifetime transfer on day one. However, periodic and exit charges can apply. If a tax payable at a maximum of 6% on this value, which means a very low price, has to be paid eliminating the issue of the huge amount of inheritance tax to be paid. Clients in their 40s and 50s find loan trust a good starting point!
Strategies No. 3: Register for Life Insurance
Considering “LIFE INSURANCE” as a loophole for inheritance tax planning will be a smart move. But the question is, how can life insurance help with inheritance tax? Whole life- insurance policies have many benefits and one of which is that they can help beneficiaries deal with the burden of inheritance tax.
If inheritance tax is due on an estate, it has to be paid before the assets of the estate are released to beneficiaries. As a result, individuals need to take out loans to cover the bills before they can receive their inheritance. The whole of life insurance can be used to clear this bill without recourse to borrowing.
Strategies No. 4: Take Advantage of Life Insurance Policy
You can also put your life insurance policy into a trust to avoid tax to pay. By doing this, your policy will be paid out without delay. The money you leave in a life insurance policy may be subjected to inheritance tax. To make sure that your loved ones receive the money you want them to have, place your life insurance policy into a trust to ensure the right people receive the right money at right time.
The principle of making money tax-free is the same as that of loan trust making a 5% withdrawal allowance for you. So, think properly and start investing today with the help of a financial adviser.
“To make sure that your loved ones receive the money you want them to have, place your life insurance policy into a trust to ensure the right people receive the right money at the right time. “
Taking whole life insurance policy and term insurance policy seriously in terms of avoiding inheritance can simply save you from paying tax and make your family and home much more secure. Both these policies allow many benefits. On the whole, there are three types of tax benefits that term insurance plans offer.
Strategies No. 5: Pay for Pensions
Pensions are normally considered as an effective way to save you from inheritance tax making it at a minimum level. There are several huge benefits that the back pension system has at the moment. The main thing is you can earn money which might be taxed up to 40% if you are just taxed on it as income. You can put that in your pension, and at that moment it’s not taxed at all.
So now it’s up to you to have 5000 pounds in your pocket or ten thousand pounds in your pension scheme. The latter option sounds good. The advantage over here is that, at retirement, you only have to pay 20% of tax instead of 40% which ultimately reduces your tax to pay. You also get a 25% tax-free lump sum of what you put into your pension.
“…it’s up to you to have five thousand pounds in your pocket or ten thousand pounds in your pension scheme… “
Once you got money out of your pension scheme, it’s never yours again. It’s owned now by the trust and not directly owned by you. You need to wait until you are 55 before you can touch your pension.
If I am to die before 75, that would result in a maximum reduction in inheritance tax because that money would never be taxed, and you will be sitting in your casket laughing at the taxman because out of pot money, my family has got 45% tax relief, and they will never have to pay that tax. That specific money will be directly hand over to your heirs and never be taxed.
It would not be part of your estate for inheritance tax. So, in terms of family, you can control money in your pension scheme, and you can draw it down whenever you like, but if you don’t need it, you can pass it without paying inheritance tax, and that’s like what everybody wants from inheritance tax planning.
Strategies No. 6: Give Gifts While Still Alive
You can also commit inheritance tax planning for sake of minimizing it by giving gifts while you are still alive. You can give money away this is a fairly straightforward mechanism. So, the general rule potentially exempt transfers, potentially because you need to live another seven years to them to be definitively exempt, are gifts made of cash, property, or almost anything.
They would normally be excluded from a death estate. Under the inheritance tax rules its seven years is a good rule of thumb! Some gifts are automatically exempt no matter when they are made even if they are made only two years before death.
In various ways, you can give away smaller sums and potentially leave them outside your death estate afterward. So, transferring your money in the form of packed wedding gifts to married couples can help you to reduce the inheritance tax bill. Spouses and civil partners can also become a source.
Strategies No. 7: Alternative Investments Markets (AIM)
Alternative investment markets also play a basic role in inheritance tax planning. Offering the prospect of tax return, many AIM stocks are also eligible to be free of inheritance tax after two years. With IHT receipts topping 5 billion pounds last year, it’s no surprise that managed Alternative Investment Markets portfolios have been rising in popularity with wealthy investors.
Investing in alternatives means investing in infrastructures like water pipelines and roads, etc. A much smarter move is to convert a specific amount of your assets into alternative investment markets where you invest your money in different projects that are nil rate band.
In this case, your investments would be atomically freed from inheritance tax making your property being passed to your descendants free of tax.
There are a large number of alternative investment markets in which individuals can invest to avoid inheritance tax. The market rate with huge profits makes it easy for people to invest in them.
These small independent alternatives do not interfere with your final tax budget and make your money full up to the mark without any minus from the tax side.
Strategies No. 8: Donate to a Charity
A simple method to make your assets and cash tax-free is to spend your money. Well, that sounds quite odd in the sense that what will you leaving behind you if you spent all the money. A much wiser answer is to convert your money into charity. Now, this expenditure ratio of money is completely up to you as you are the one who decides that how much money needs to be spent on charity.
Most financial advisors suggest spending your money in such a way that the nil rate band does not get crossed, which means it should be less than 35,000 pounds. Now, what benefit can you get when you do charity for a certain amount? To understand this, we shall proceed with an example.
For example, if you are a married couple, filing your return jointly, and you make £100,000 a year in taxable income, then your highest marginal tax rate is 25%, so the way that a charitable donation make-work is that like this: if your taxable income is £100, 000 and you, throughout the year or at a onetime gift decided to give £5000 to your local church or whatever charitable organization, the £5000 reduces the top level of year income rate giving £1250 as a tax benefit.
“Proper Inheritance tax planning is required to decide about the proper amount to be donated in a charity to avoid tax to pay. “
You will be benefited from tax benefit because you give charity that lowers your income which automatically lowers your taxes, but since your tax marginal bracket moves into the next lowest level, now, the majority of your income is going to be taxed at fifteen percent, ten percent and zero percent instead of having income taxed at 25 %.
So, your tax bracket gets lowered offering a huge difference and a reduction in inheritable tax. Proper inheritance tax planning is required to decide about the proper amount to be donated in charity to avoid tax to pay.
One more thing should be kept in mind that donating money for charity is a personal sue regarding what you feel about the cause and care about other people. But if you want to limit your inheritance tax bill you can surely follow the above steps provided.
Strategies No. 9: Utilize Exemptions and Reliefs
Capital gain tax can be managed by considering all available reliefs and exemptions. The use of exemptions can make a huge difference in inheritance tax planning. These may be in the form of annual exemptions, small gifts exemptions, and normal expenditure out of income exemption.
It is possible to make gifts to certain people and organizations without having to pay any IHT. There is no limit on the amount that can be gifted to them, which means the amount given will all be exempt from IHT.
Some gifts cannot be included in the estate even if the individual dies within the seven years of making the gift.
The use of annual exemptions means the usage of three thousand pounds can be gifted each tax year without any tax to pay. Small gifts exemption allows for a gift of up to 250 pounds to be made more than one individual in any one tax year without it be subjected to tax.
So, just by covering your exemptions, you can simply reduce your inheritance tax.
Strategies No. 10: Utilize Business Reliefs
Utilizing allowances that, although you own the asset, the assets are not chargeable for inheritance tax can lead you to a much bigger relief termed as business relief. This relief allows you to make your assets outside of your estate, if you hold them for a couple of years, making your burden free from inheritance tax.
The original purpose of this business relief is to hold trading companies. For instance, if somebody owned a company and they are working in it and they employed staff. If inheritance tax got a charge on the value of that business when the person died, it would cause all sorts of problems.
If there were a few hundred thousand to pay out in tax, then the business would not have the kind of cash flow. The business has to shut a whole bunch of employees to be made redundant. So, it makes no sense to charge inheritance tax from such companies.
The condition over here is to hold the asset of the company for two years. It specifies investing in one major project rather than many versatile different projects. This process can reduce your inheritance tax by reducing your actual income but is risky at the same time. Business reliefs and many other reliefs play an important part in inheritance tax planning.
Combing all the above factors or strategies were different methodologies that help people in not giving a maximum amount in tax. Financial advisors use these strategies frequently and highly recommend them. Who wants to pay money to the government as a tax at the time when they want to secure their future?
Inheritance tax planning in the form of proper will and other aspects can help you to withstand this tough situation and tough time. You can follow these instructions making investments much easier.
Inheritance tax is something that is paid by the decadents on the property passed on to them. Many strategies can help you to make your expenditures less in the form of avoiding income tax legally.
A lot of emphasis should be given over here to the word “legally” because this start does not offer any illegal way that will put you in trouble. These methods allow you to work smartly and wisely to adopt ways that are never illegal.
Start thinking about your future today and try to secure it for your kids and spouses or civil partners so they can lead an independent life after you leave them. Man is mortal and we can’t think of living forever moreover. There is no cupboard in the grave and we cannot take our money and assets with ourselves.
Try to act on these improvised and fabricated tricks to make the world a better place for your children by making them less burdened to pay inheritance tax. For this purpose, proper inheritance tax planning is required which can be offered by a financial advisor that will make certain plans for your certain bank balance.
References:
Ginn, Jay. Gender, pensions and the life course: how pensions need to adapt to changing family forms. Policy Press, 2003.
Wrede, Matthias. “Fair inheritance taxation in the presence of tax planning.” Journal of Behavioral and Experimental Economics 51 (2014): 12-18
Dacey, Norman F. How to Avoid Probate. National Estate Planning Council, 1965.