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Reducing inheritance tax

The government’s inheritance tax take surged 9% to pass more than £5 billion for the first time in the year to May 2017, according to HMRC – and bills are expected to rise further.

However, you could reduce the impact on your estate after two years, thanks to Business Property Relief. Our financial planning expert, Anthony Ward, explains.

Inheritance tax is rising for a number of reasons. For several years now, the inheritance tax threshold – below which no tax is payable – has been capped at £325,000. It’ll remain capped at this level until the end of the tax year to 5 April 2021. At the same time, property and other asset prices have risen strongly, increasing the value of estates.

Ways to reduce or mitigate inheritance tax include gifts and trusts, but these can take seven years to be fully effective. They can also involve compromises, such as giving up control and access to your assets.

This is where Business Property Relief (BPR) can help. Where it applies, you can reduce your inheritance tax liability in two years and retain control of your assets.

What is Business Property Relief?

BPR is a tax relief designed to increase investment in certain types of trading businesses. It was introduced by the UK government in 1976.

It means you are exempt from all inheritance tax if you own a business, an interest in a business or partnership, or unquoted shares. Other investments, including land, buildings, plant and machinery used by relevant businesses, qualify for 50% inheritance tax relief. Business property must be held for at least two years before death.

What are Business Property Relief portfolios?

A number of specialist firms offer BPR portfolios. They usually buy baskets of unquoted shares on behalf of investors, and use a wide range of investment strategies to suit individual preferences. There are risks, however: no matter how well they’ve done in the past, shares can still fall in value, and shares in smaller, unquoted companies can be riskier and less liquid than quoted shares.

Case study

Mr Smith’s estate is worth £4 million, including a £1 million house, investments of £2.2 million, and £800,000 in cash. He has no mortgage on his house and intends to live there until he dies. His wife died five years ago and at this time used her nil rate band by leaving assets to their children.

He is 75, has two children and four grandchildren. Recently, he has started looking into ways he can maximise the value of his estate for his beneficiaries and mitigate his exposure to IHT.

If he does nothing, his beneficiaries face an inheritance tax bill of £1.47 million. So he decides to invest £600,000 into a BPR portfolio. After holding these BPR shares for two years his investment is exempt from tax. The IHT bill is cut by £240,000 (40% £600,000) if he still holds the shares when he dies.

Mr Smith can take money from the BPR portfolio without affecting the inheritance tax exemption he will receive on what remains.

For simplicity, our example does not include any rise or fall in the investments over the two years.
You need to bear in mind that tax rules can change in the future and that their effects on you will depend on your individual circumstances. We do not offer personal tax advice and recommend that you get independent advice.
The value of an investment can go up and down, and will be subject to product charges. The value of an investment being maintained or increasing is not guaranteed.

Investment in smaller unquoted companies carries a higher risk than many other forms of investment. In addition, investments in unquoted companies will have limited liquidity compared to listed companies.

Appendix: how does inheritance tax work?

You pay no inheritance tax up to a threshold of £325,000, which is known as the nil rate band and is frozen until the end of the tax year to 5th April 2021, when it is set to increase with inflation. Tax is charged at 40% on amounts above this threshold.

The threshold applies to each individual in a marriage or civil partnership. Gifts between spouses or civil partners, whether made in life or on death, benefit from a spouse exemption – they can be passed on tax free to the survivor, as can any unused nil rate band. The surviving partner can currently leave up to £650,000 tax free to beneficiaries.

A new family home allowance, introduced earlier this year, will increase the individual threshold gradually to £500,000 (or £1 million for a married couple or civil partners when taken together) by the start of the tax year 6 April 2020, when the estate includes a family home which is being passed to lineal descendants. However, those estates that are worth more than £2 million will lose some or all of the additional family home allowance, which will be tapered at a rate of £1 for every £2 over the £2 million threshold.

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The value of investments can fall as well as rise. You might not get back what you invest.