The inheritance-tax (IHT) grab continues to intensify. The combination of frozen tax thresholds and soaring property prices saw HM Revenue & Customs (HMRC) take £5.5bn in IHT between April 2021 and February 2022 – around £700m more than in the same period last year. With the basic IHT threshold set to remain at £325,000 until at least 2026, tens of thousands more families face being dragged into the net in the coming years.
This makes it even more important that you organise your savings and investments in the most tax-efficient way. The first principle to grasp is that private pension saving almost always falls outside of your estate for IHT purposes. That means it can be passed on to heirs without an IHT bill to pay.
How that works in practice will depend on your age when you die and what type of pension you have. Broadly speaking, any cash left in a defined contribution pension fund can be passed on to your heirs. They’ll pay income tax on the money only if you were 75 or over at the time of your death. There are a few exceptions to this: for example, money from a pension put into drawdown before 6 April 2015 will be subject to income tax even if you are under 75 when you die.
Spend taxable savings first
Since IHT is not payable on pension cash left to heirs, it makes sense to run down other savings later in life before tapping into your pension cash. If you reach retirement with, say, cash in both individual savings accounts (Isas) and private pensions, it’s a good idea, all other things being equal, to use the former first. Isa savings count towards IHT calculations, so running these down before you turn to your pensions reduces your heirs’ potential liability to tax.
What if this is not an option because you’ve chosen to build up savings for old age through non-pension vehicles and don’t have much in pensions to leave? One option is to rethink how these savings are invested.
In particular, most shares listed on Aim, the UK’s small-cap index, do not count towards your estate for IHT purposes because the government is keen to encourage people to invest in less mature businesses. Accordingly, by shifting some of your retirement savings into a portfolio of Aim stocks, you’ll be taking this money out of the IHT net. You can do that inside or outside an Isa, but if your Aim holdings are inside a tax shelter, there will be no other taxes to worry about either.
In practice, the performance of Aim shares tends to be more volatile, so you wouldn’t want all your retirement savings invested in this way. However, this can be a good way to mitigate some IHT risk. There are a number of specialist firms that run Aim portfolio management services targeted at families planning for IHT.
Consider all reliefs
The technical name for the exemption of Aim shares from IHT is Business Property Relief (BPR). Full relief is often available on your own business, and 50% BPR relief on land, buildings or machinery used by a business that you were a partner in or controlled. Take advice on how this might affect your heirs’ liability to IHT.
Finally, if you’re struggling to reduce your family’s IHT liability through investment planning, don’t forget other mainstream IHT strategies. In particular, by giving assets away, you’ll reduce the size of your final estate. There are a wide variety of options for making both small and large gifts of this size.