In April 2023, the National Will Register reported that 42% of adults in the UK had not made any provisions for their estate distribution in the event of death. This leads to individuals having no control over how the estate is eventually distributed and increases the likelihood of a high inheritance tax (IHT) charge suffered by the beneficiaries. To ensure that inheritance left behind is maximised with a minimum tax charge, a number of planning measures can be considered when a will is drawn up, including those outlined below.
Exempt Beneficiaries
The primary advantage of a will is that the deceased’s estate is distributed according to the wishes of the individual. A popular measure is to leave the entire estate to the spouse or civil partner, as this could lead to the entire inheritance being exempt. Charity organisations are generally also exempt beneficiaries. Not only is the asset donated to a charity treated as an exempt transfer on death, but if the transfer is more than equal to 10% of the estate’s baseline amount, the IHT charge goes down to 36% (from 40%). The baseline amount is the estate’s value after adjusting for any exemptions and the nil-rate band (NRB) but before the charitable donation and residence nil-rate band (RNRB) are dealt with.
Exempt Transfers
If the individual has children who are minors, they can set up a bare trust in their will. This results in the assets transferred to the trust being managed by the trustees until such time as the beneficiary comes of legal age, whereupon the rights to all the capital and any income from the asset pass to the beneficiary. Not only is this an effective way of protecting the interests of the dependents, but transfers to a trust result in the asset being excluded from the death estate calculation, leading to a reduced IHT charge.
Life Policies
Another option is setting up a life insurance policy in trust. This will exclude the policy payout from the death estate calculation, but the payout can still be made to the beneficiaries specified in the instructions to the trustees. Any risk of lifetime IHT on the premiums paid can be reduced or avoided by using the annual exemption of £3,000, or by ensuring that the premiums satisfy the conditions to fall within the ‘normal expenditure out of income’ exemption (see IHTA 1984, 21(2)).
Reduction in Tax Charge
In the context of families, an effective double IHT charge can be avoided if the individual ‘skips’ a generation when specifying the beneficiaries in the will. Assets left to the children will lead to an initial tax charge that will repeat when these assets are then transferred to the next generation.
The family as a whole can potentially save tax if the initial inheritance is bequeathed directly to the grandchildren, leading to a single tax charge on the assets transferred.
Naming direct descendants (children or grandchildren) as the beneficiaries of the residence possessed by the individual will lead to the deduction of £175,000 RNRB in the taxable estate calculation. This will lead to a direct tax reduction of £70,000 (i.e., £175,000 x 40%) and may be doubled if the unused RNRB of a deceased spouse or civil partner is available.
Investing in unquoted or quoted shares and securities of trading companies controlled by the individual can lead business property relief, provided assets have been owned for at least two years. Depending upon the type of investment, the relief can reduce the value of the investments by 50% or 100%, thereby possibly eliminating or reducing the tax charge.
As long as the individual is of sound mind and not under any undue pressure, the document written, signed, dated and witnessed by two independent witnesses will be legally valid.
Practical Tip
A will can easily be replaced by a new one; or a codicil could be drawn up to amend the current one.