Insurance underutilized tool against IHT says Continuum

by | Aug 14, 2023

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As the Government works on closing many of the loopholes around the use of trusts, pensions and gifting to avoid paying inheritance tax, insurance is an underutilised tool, according to national IFA Continuum.

With speculation about inheritance tax reforms being part of the agenda for the next General Election, more consumers are becoming aware about the tax, but few have plans to mitigate against it on their death.

Over £7bn a year is now collected by HMRC from inheritance tax, and the tax take is set to soar over the next five years.

If your estate is worth more than £325,000 when you pass away, IHT could be charged at 40% on everything over the threshold, leaving your family with a massive bill. The main residence nil rate band, currently £175,000 was introduced as an additional nil-rate band when a residence is passed on death to a direct descendant. Gifts left to charity in your will be taken off the value of your estate before inheritance tax is calculated and will reduce your Inheritance Tax rate, if 10% or more of your estate is left to charity.

 
 

Inheritance tax was conceived as a tax on the wealthy classes, but decades of inflation have spread the burden from landed gentry to ordinary people.  

With the Government closing many of the loopholes around the use of trusts and pensions to avoid IHT, insurance is an underutilized tool against the inevitable, according to national IFA firm Continuum.

Ben Alcock, Chartered Financial Planner at Continuum, said: “Trusts used to be a simple answer to pass down wealth tax efficiently, but they can be complicated and many of the loopholes that made them so effective in the past have been closed.

 

“Giving wealth away during your life is one way to cut the bill your family will have to pay after you are gone but there are strict rules on how much you can give.

“Using your pension has become a popular way of passing on money without paying IHT but HMRC is currently proposing closing this loophole too.

“However, if set up in the correct way, taking out a whole of life insurance policy can provide a large sum payable on death which executors can use to cover your IHT liability, leaving your legacy intact. 

 

“These are only some of the possible solutions. A professional financial adviser can help you ensure your wealth goes where you actually want it to. 

“IHT is charged at a fixed rate of 40%, meaning the taxman will be enjoying the fruits of your labours, while your loved ones are deprived of the help you want to give them.

“It could be help they desperately need. Decades of house price growth have all but frozen first-time buyers out of the property market, while millions of workers face an uncomfortable retirement.

 

“The important thing to understand is you need to act, and it is never too early to do so.”

Ways to ensure the taxman does not take your family’s inheritance:

1.      Give it away

 

Giving wealth away to them while you are alive is one way to cut the bill your family will have to pay after your death.

But as you might expect, the taxman is not keen on this kind of largesse and sets rules on how much you can give.

He will allow you to give away £3,000 a year IHT-free. You can also give £2,500 to a grandchild in the year of their wedding, or £5,000 to your child who is getting married. 

 

Give larger sums, and they will be counted as part of your estate when you pass on, and your loved ones charged accordingly, unless you survive for another seven years. 

This does not just apply to money. If you give away your home while you are alive, you need to live seven years – and pay market rent to the new owner – for it to move outside your estate for IHT purposes.

2.      Use a trust 

Trusts used to be a simple answer to pass down wealth tax efficiently, but they can be complicated – and many of the loopholes that made them so effective in the past have been closed. 

With a bare trust, the simplest option, you hold the assets as nominees for your children or grandchildren. The beneficiaries will have the legal right to the assets once they reach the age of 18 (or 16 in Scotland). 

There may also be tax implications. There is no limit on how much can be transferred into a bare trust. But you might still need to survive for 7 years to avoid IHT.

Trusts still have their uses – but they might be more effective if you are leaving your wealth to grandchildren rather than children. 

3.      Use your pension

You could choose to gift your private pension on your death. This can be inherited by whoever you choose on your expression of wishes form, free from IHT. However, they will still pay income tax if you die after the age of 75 at their rate of income tax. If you die before 75, no income tax is payable – although HMRC is currently proposing charging income tax on inherited pensions where the policyholder dies BEFORE age 75.

4.      Insure against the inevitable. 

The simplest answer of all could be an insurance policy. If set up in the correct way, taking out a whole of life insurance policy can provide a large sum payable on your death which your executors can use to cover your IHT liability, leaving your legacy intact.

5.      Turn to a financial adviser

A professional financial adviser can help you ensure your wealth goes where you actually want it to. 

It is important to pick an independent financial adviser who has a specialism in intergenerational wealth planning.

According to research published this week by HSBC, four in ten financial advice firms do not have a clear strategy for intergenerational planning, and just one in three have discussed wealth transfer plans with their clients’ children.

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