Tax Efficient Savings: How Can I Pay Less Inheritance Tax?

As the new tax year begins, many will be starting to make use of allowances and exemptions in order to preserve their wealth for future generations and avoid an inheritance tax (IHT) liability. With the nil rate band having been frozen at £325,000 since the 2010/11 tax year, and other allowances such as the annual exemption (£3,000) having remained at their current level for many years, more people find themselves with a potential IHT liability, and so must carefully devise a tax efficient plan to manage their finances.

At a recent meeting with new clients, the Smiths, I reviewed their circumstances along with their financial goals in order to help them with a potential IHT liability of their own. The couple’s main objective was to ensure they had enough money for their own future as well as passing on as much of their hard-earned gains to their only son – and anticipated grandchildren – as possible.

Upon reviewing their current assets, it was clear that there were certain challenges in place. The Smiths had a large portfolio of investments with money held in many different types of investments and various tax wrappers, and as this had built up over the years there was no coherent plan or strategy in place.

Also, the couple had already gifted large amounts of capital in recent years and had exhausted their available allowances, and so were reluctant to gift any more away to not compromise their position.

Lastly, they were also concerned about their advancing age and deteriorating health, and so wanted any solution to have a quick impact.

As well as building up a good understanding of their goals and objectives, I sought to understand their income and expenditure in detail, and their existing portfolio of savings investments.

Both clients were still working and wanted to continue to do so for as long as possible. Between them, they were in receipt of secured pension income that itself exceeded their expenditure and effectively rendered their earnings surplus to requirements, and had far more cash on deposit than they required given their plans.

Having a greater understanding of their circumstances, I was then able to identify some immediate opportunities to improve their position.

As both Mr and Mrs Smith were still working and aged under 75, it was possible for them to pay into personal pensions and gain income tax relief on the contributions. It was confirmed that their pensions were structured in such a way that they were not considered part of their estate, and so given their potential IHT liability it provided an efficient way to provide for their own retirement needs whilst also offering an opportunity to pass on funds to their beneficiaries tax-efficiently upon death.

The Smiths’ ISA portfolio also presented an opportunity. Although very tax-efficient during their lifetime, with no tax being payable on income or capital gains, ISAs are potentially subject to inheritance tax on death and, if invested wisely, are likely to grow over time.

As the nil rate band is fixed until 2026, it seems likely that any potential IHT liability will also grow. However, an effective way of keeping the ISAs invested – and within the control of the investor – but limiting the IHT problem is to hold funds that produce a natural income and to then gift this income away.

Although the Smiths were not comfortable with the idea of giving away capital, they felt that they could afford to give away growth in the expectation that the capital values would remain broadly stable over time.

After assessing the Smiths’ overall position, it was also felt that they were able to invest some of their available funds in an investment solution that would qualify for Business Relief. These investments offer a way for clients to mitigate IHT quickly, with these funds being deemed to be outside the estate after being invested for 2 years, without the need to give up control or access. They are deemed to be higher risk due to the types of assets that qualify for the relief, but for the right client they offer an effective way to reduce a potential IHT liability.

All in all, the actions taken by Mr and Mrs Smith could save them hundreds of thousands of pounds in inheritance tax, depending on how long they live. It will be imperative to review their position on an ongoing basis however, to ensure that their planning remains appropriate for the changing tax landscape.

If you require assistance in managing a potential IHT liability or have any questions regarding your own tax planning needs, please do not hesitate to get in touch with one of our Independent Financial Advisers today on 0117 450 1300.