Inheritance tax planning tips from houses to pensions
Clear communication during lifetime can forestall a lot of misunderstanding when it comes to inheritance issues, but tax planning is critical, explains Ian Dyall, head of estate planning at Evelyn Partners.
Ian Dyall, Head of estate planning, Evelyn Partners (Accountancy Daily)
Fans of the hit HBO television series Succession will know that the passing on of Logan Roy’s business empire has been anything but smooth - a state of affairs that gives the show its dramatic tension. With the death of the media mogul and paterfamilias in season four, the comic drama reached a critical point that it had been building up to since the first episode.
But in keeping with the makers’ love of narrative twists, even post-mortem Logan’s intentions remain a point of debate and conflict as a note, which seems to be many years old, appears to name Kendall as the business successor but is rendered dubious by an alteration - or is it an underlining? The wrangling and power plays continue.
Uncertainty over the handing down and division of estates is not uncommon and conflict can arise over assets of any size.
‘You don’t have to be leaving a media empire to your family for there to be a potential for misunderstanding or friction,’ Dyall said.
'Lack of communication during lifetime, poorly drafted wills, assumptions around the family home, ignorance of inheritance tax rules, and strong emotions can each or in combination make the distribution of an estate problematic and disrupt the transfer of wealth.
Moreover, inheritance tax is now a mainstream issue. Growth of asset values coupled with the fact that the nil rate band, unchanged at £325,000 since 2009, will remain frozen until at least April 2028 means many more states of relatively modest size are being drawn into the IHT net every year.’
IHT receipts for April 2022 to March 2023 were recently reported at £7.1bn, which is £1b higher than the same period a year earlier.
Forecasts published by the Office of Budget Responsibility on the same day as the Budget predicted that between 2022/23 and 2027/28 the Treasury will collect £45bn in IHT receipts, a rise from the £42.1bn estimate released last November, although even this looks like it could easily be overshot.
Dyall said: ‘The irony is that the majority of such difficulties can be prevented or diminished by some careful steps in estate planning. Families of course vary a great deal in their dynamics and estates in their complexity – as the Succession saga demonstrates – but the same broad guidelines usually apply.
‘One of our clients recently contacted us after their cousin had died and left a will that was invalid, as it was only witnessed by one person. However, it was only after the ‘executor’ had contacted several beneficiaries named in it that the will was discovered to be invalid.
The rules of intestacy dictated a very different distribution of the estate as most of the people named in the invalid will were not blood relatives – and the blood relatives who did benefit could not agree on whether or not to honour the spirit of the will.
Not only that, but the estate breached the IHT exemption by about £20,000, creating a tax bill that could probably have been averted with some planning.
In other words a lot of awkwardness, admin and expenses that could have been easily avoided.’
Dyall recommends five steps that can be taken to plan a quarrel-free succession:
1. Involve your family and discuss intentions
Clear communication during lifetime can forestall a lot of misunderstanding. It’s usually preferable if the executor and beneficiaries are made aware that they are named in the will. Beneficiaries are often family and as many families default to the standard ‘Spouse inherits, then children inherit equally on death of second spouse’ format, this can be straightforward.
More complicated or perhaps even controversial distributions might be more difficult to discuss, and those who don’t wish to do so during their lifetime might consider a Letter of Wishes to explain and clarify their intentions alongside the Will.
Even where the passing on of an estate’s main assets is fairly straightforward, disputes could still arise over things like who is allowed to keep items of sentimental value or familial heritage if this isn’t discussed in life.
2. A clear, correct Will and good records
It has been estimated that 60% of UK adults, around 30m people, don’t have a Will in place, and if that remains the case their estate will be distributed according to the rules of intestacy.
Anyone who wants to avoid that outcome must make a Will, preferably with legal advice, and have its signing properly witnessed. It is easy to be wrong-footed by the intestacy rules and some people assume that assets will go to a loved one – a long-term partner for instance - when the law dictates otherwise.
It will also help the executor in the distribution of the estate if clear records have been kept of all assets, and along with the Will are easily located.
3. Gift during lifetime and consider a trust
Logan Roy would probably struggle to make much of a dent in his estate with the annual gifting limits, but the ‘seven-year rule’ does allow you to give away as much as you like during your lifetime, as those assets will leave the estate for IHT purposes if the person making the gift lives for another seven years.
But gifting is not just an IHT mitigation issue: for many of the so-called post-war baby boomer generation it is done to help out their adult children and their families, so the donor gets the benefit of seeing their gift make their loved ones financially secure. This is particularly relevant amid a cost of living crisis. Judging by the lifestyles of Kendall, Shiv, Roman and Connor in Succession, Logan Roy had been fairly generous with his lifetime gifts.
To avoid ill-feeling most parents will try to equalise the gifts they make between children – but there is also the possibility of making good any inequality in lifetime gifts with the distribution of assets in a Will. Again, this could be clarified with a Letter of Wishes.
Many parents want to make large gifts during lifetime but are afraid that they might run out of money before they die, particularly if they end up having to pay for care. Cashflow planning can be used to calculate how much access will be required to ensure that there is sufficient money available to pay for care if required, and by careful use of specialist trusts, sufficient access can be maintained whilst minimising the inheritance tax liability. There can be some other tax consequences to consider however, and as a generally complex area, trusts are best arranged with estate planners.
4. Think about the family home
There can be sticking points among siblings who are left an equal share in the family home when their second parent dies, as the beneficiaries may differ in their opinion about what should happen to the property. This can be particularly awkward if one sibling has been living in the property - whether that has been all their life or, for instance, since the parent went into residential care - and wants to remain there.
This can be a difficult issue to address. It may be possible for the one party to buy the other share of the property from their sibling, either by using their own money and their share of the liquid assets in the estate, or by mortgaging the property.
In some cases, providing a greater share of the home to the child who has provided care for the parent in their later years is seen as fair compensation, particularly if they have curtailed their career to do so. Again, communication of the reasoning will help prevent family disputes.
5. Don’t forget the pension
Defined contribution pension pots are not legally part of an estate and are therefore exempt from IHT. If the pension holder dies at age 75 or over no IHT will be due but income tax will be levied on the nominated recipient of the pension at their normal income tax rate as the funds are withdrawn.
If death is before age 75 no income tax or inheritance tax will be payable. Until recently this was limited by the lifetime allowance (LTA), which meant that large pots over £1.07m could attract an excess tax charge of up to 55%.
The LTA charge, however, was cancelled at the last Budget, leaving no limit on how much can be saved tax-efficiently into a defined contribution pension pot. The LTA has become a bit of a political football and it remains to be seen whether its removal lasts beyond the next general election.
Either way, those who have planned their estates carefully might use up other assets before their pension, on the basis that less IHT is likely to be due on the estate. Most occupational defined contribution pension schemes ask for an ‘expression of wish’ or ‘nomination of beneficiaries’ indicating who receives your pension pot on death – so it is important to make sure such details are up to date on old pension pots.
More than one person can be named as a beneficiary so the pot can be split. A pension could be the second largest asset after the home, and sometimes the largest asset.
It’s fairly clear in Succession that Logan Roy is not as concerned by the peace of mind of his children as he might be, so it’s perhaps no surprise that he didn’t manage to arrange a smooth transfer of wealth.
As most parents are a bit more caring, they will want to take these steps to pass on their estate with as little stress as possible for their grieving loved ones – and without gifting too much to the taxman.