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.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
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.
-
British Airways revamps Avios scheme bringing down flight prices to £1With the new Avios part-payments scheme you can now bag a British Airways flight for as little as £1
-
RBS to close a fifth of branchesRoyal Bank of Scotland plans to shut 18 branches across Scotland, resulting in the loss of 105 jobs. We have the full list of closures.
-
Act now to bag NatWest-owned Ulster Bank's 5.2% easy access savings accountUlster Bank is offering savers the chance to earn 5.2% on their cash savings, but you need to act fast as easy access rates are falling. We have all the details
-
Moneybox raises market-leading cash ISA to 5%Savings and investing app MoneyBox has boosted the rate on its cash ISA again, hiking it from 4.75% to 5% making it one of top rates. We have all the details.
-
October NS&I Premium Bonds winners - check now to see what you wonNS&I Premium Bonds holders can check now to see if they have won a prize this month. We explain how to check your premium bonds
-
October’s NS&I Premium Bond winners revealed - have you scooped £1 million?Two lucky NS&I Premium Bond winners are now millionaires this October. Find out here you are one of them
-
The best packaged bank accountsAdvice Packaged bank accounts can offer great value with useful additional perks – but get it wrong and you could be out of pocket
-
Bank of Baroda closes doors to UK retail bankingAfter almost 70 years of operating in the UK, one of India’s largest bank is shutting up shop in the UK retail banking market. We explain everything you need to know if you have savings or a current account with Bank of Baroda
-
The best options to earn cashback on spendingFrom credit cards and current accounts to cashback websites, there are plenty of ways to earn cashback on the money you spend.
-
Should you retire abroad?Check the regulations governing pension savings carefully before you decide to retire abroad.
