This episode of The Money Compass podcast was published on 22nd February 2023. You can listen again by heading to our Episodes page, or on your favourite podcast player.

Have you started your IHT planning?

Emma Knights is joined by the Executive Business Development Manager at Blackfinch group, Vince Keen. Our special guest explains Inheritance Tax Planning, when IHT is chargeable, allowances and ways to mitigate the costs of IHT with a range of different solutions.

IHT Planning

Emma Knights
Today, I am joined by Vince Keen from BlackFinch. Hopefully, you can tell us lots of different things today about Inheritance Tax.

Vince Keen
Good afternoon, Emma, good to see you. Thank you for inviting me along.

Firstly, just a bit of background about me, an introduction from me, Vince Keen, Business Development Manager at BlackFinch investments and we are a specialist provider of tax investments. This is including investments that can help clients address their inheritance tax issues, or IHT as it’s otherwise known.

My career in financial services dates back over 30 years, and in the past 14 years, it’s been in supporting financial advisors across the East Anglia region, helping their clients in the area of tax efficient investments. Inheritance tax can be a really complex area, so it is important to seek professional advice from financial advisors, legal advisors, etc. when looking at the different ways in which you can mitigate the tax and hopefully save you a lot of money.

One thing I just need to stress, it is important to understand that neither myself, nor BlackFinch, can give advice in this area. Our role is working with financial advisors who are then considering these solutions for their clients.

Emma Knights
Most definitely, hence why we come to you and ask lots of questions, but we are the one that ones that actually advise our clients and share that information and advise them on their own situation. I absolutely, 100% agree with that.

Obviously, we have mentioned IHT, what is IHT and how does it work so that people understand? We get lots of clients come to us that say, “I think I have got an IHT problem”, and some of them have absolutely nothing to worry about. Yet others, have this huge problem and have no idea. I think it is very unclear to people, what IHT is and how it works. Tell us a little bit about it.

Vince Keen
I will apologize now for loads of jargon and acronyms, this whole world of tax is built with it. I will try and keep it simple and explain some of the terminology. In effect, inheritance tax is paid on your estate, which is the value of someone’s assets, this is what they leave behind when they die. Your estate will include a number of things including: your house and properties, it will include savings and investments, and also other assets you own. That could be valuables like jewelry, car, etc. There are certain things that are excluded, certain types of pension funds, for example, are not included in that. Any outstanding debts are then deducted from this. That calculates effectively, what we call the net value of your estate.

Not everyone will pay inheritance tax because there are a number of attractive allowances, the main one being the Nil-Rate band. Basically, the first £325,000 of value of your state is not subject to inheritance tax. If your estate, on the event of death, is less than £325,000, you are not normally going to pay inheritance tax. However, if the value of your state is £325,000, the excess is then charged at 40%, which can be quite a significant amount of tax.

Emma Knights
I think that 40% is shocking to people that think “I have paid all these taxes in my lifetime”. That is a huge amount on death. It is something that people just need to understand to realise there is planning that you can do to mitigate that as much as you can.

Vince Keen
Yes, absolutely. Another point just to add to that though, if you are leaving everything to your spouse, if you are married, or in a civil partnership, there is no Inheritance Tax to pay on first death, however obviously, everything is now with your spouse. Also, if you are leaving your estate to charity, there are certain things you can leave it to, where you will not pay Inheritance Tax.

Emma Knights
So that is the absolute basics of Inheritance Tax, but I know there’s more allowances and it carries on further. So, do you want to keep us going with those?

Vince Keen
Yes, absolutely. There was a new allowance that was introduced back in 2015, mainly for people who own their own property, and where that property is going to be left to their direct descendants. That is typically going to be children or grandchildren. Property prices, if you are aware, have increased dramatically over the years. Therefore, more and more people are getting caught by Inheritance Tax. This residence Nil-Rate band means you’ve got an additional allowance of £175,000. This means on top of the £325,000, an individual potentially now has an allowance of £500,000. Therefore, if you are married, your combined total is a million pounds.

It is a complex area, not everyone will be eligible for that. If you do not own a property, you do not have children, or there is other things, it can impact that benefit. If we give a simple example: married couple, total estate value of £1,200,000, in the event of second death those £200,000 pounds above that total allowance of a million, which is thus taxed at 40%, would result in an £80,000 Inheritance Tax bill. When you say £80,000, that is a huge amount of money that people have worked for their entire lives, which they expect to pass on to somebody else. If all of a sudden there is this bill to pay, why would you want to pay it if you don’t need to?

Like you say, there are so many people out there that probably aren’t even aware they have the issue. It is important to do some kind of analysis on your assets. There are other things to include in that. You can have life insurance policies. If they are not written in trust, they are added back into your estate. It is not as simple and straightforward as it looks. If you know about it, at least you then know there are options to address.

Emma Knights
Most definitely. How much Inheritance Tax do people pay in the UK? Is it a big tax, how much is that?

Vince Keen
It is massive. If we take last year as an example, in the last tax year, over 6 billion pounds was paid in Inheritance Tax. That is the highest on record. Forecasts from the government, suggests that it is going to increase again dramatically over the next few years. It is not just the amount of tax that is being paid, more and more estates than ever are paying Inheritance Tax. It is impacting more people.

If we think about the £325,000 allowance, that was last changed in 2009. These allowances are now frozen until 2026. For 17 years, we have seen no increase in that allowance, but they have the residence Nil-Rate band on top. It means that just through property valuation increases and everything else, there is no surprise that more and more people are getting caught by this. As you say, there are ways in which you can mitigate it. It is a voluntary tax, it can be avoided, spending your money would be one thing.

Emma Knights
If you want to do that, then so be it. Absolutely enjoy it.

Vince Keen
That is my plan, there are things that you can do and as far as I say, it is important to get advice to consider what those options are.

Emma Knights
I know that is obviously one thing that a lot of clients say to us, ‘they have no idea what the allowances are’, understanding that is one really important part. Another thing that we get asked, I would say on a weekly basis, is what gifts can be made that are IHT exempt? What can people do, and not be causing themselves a huge liability without even realising it?

Vince Keen
Absolutely, so we will cover off some of the basic gifts.

Emma Knights
I do know there is a huge list of these.

Vince Keen
I have only covered off some of the key ones, however, for example, each person can give away £3,000 per year, and that would be exempt from Inheritance Tax. If you have not used your full allowance from a previous year, you can also carry that forward, but you can only ever do that once. It is important to keep records of gifts. This is because if your state is assessed at the time of death, you want an audit trail there to document and evidence what you have done.

Emma Knights
I think that is something a lot of people will be guilty of not doing.

Vince Keen
Yes, absolutely. That is more important when we come onto the larger gifts as well in a moment. That £3,000 allowance was last changed over 30 years ago.

Emma Knights
That would have been a lot of money to give to people, wouldn’t it?

Vince Keen
Absolutely, when now it is not really kept to pace with inflation. Again, it is something else that probably does feel not that attractive. Some other gifts, for example, will be for weddings. If your children are getting married, you are allowed to gift up to £5,000 towards their wedding, it is £2,500 for grandchildren, and £1,000 for anyone else. Then there is a small gift allowance, you can make up to £250 a year worth of gifts to as many people as you want, but it cannot be the same people who have benefited from those other gifts.

They are probably some of the key ones, and the other one to mention is if you have got surplus income, and you are making those gifts out of your surplus income, it is not impacting your standard of living, then they will also be exempt from IHT. It is important to keep the records to evidence that it was ever looked into.

Emma Knights
Definitely. There is quite a few things that you can do to try and reduce your estate, but I suppose the previous example where they had an excess of £200,000 and they were paying £80,000 in tax, using those small gifts allowances, it’s going to take you a long time to burn through giving away £200,000 to reduce that tax.

Vince Keen
That leads quite nicely into the larger gifts and what is often referred to as the seven-year rule. So again, many people will be aware that you can give as much as you want away, but it is then a case of how that could be impacted for your Inheritance Tax. The simple rule of thumb here is that if you give away larger investments or larger amounts of capital, and you survive for at least seven years, then that would be outside of your estate, and then effectively exempt from Inheritance Tax. However, if you die within the seven years, that amount is added back into your estate, and will use up some of those allowances, meaning you will still be paying Inheritance Tax on the rest of your estate.

Emma Knights
Even though you have not got the money, you are still essentially paying the tax on it, because it is brought back into your estate.

Vince Keen
If you are in a position where you can afford to give that money away, you want your children, grandchildren to benefit from that and use that money now. Absolutely, you want to see them enjoy it.

Emma Knights
I think that is much more common now, a lot of people are starting to realise, ‘what is the point of saving all this money until I’ve gone, why not give it to them now to be able to enjoy it? If I can afford to do it’. It is understanding the consequences of doing that now and how it is going to impact you potentially later.

Vince Keen
Absolutely, one of the points to add to that is if you are making larger gifts, where the combined total of those are above your allowance of £325,000, what that effectively means, though, is the rate of Inheritance Tax you pay, will start to gradually reduce once you have survived at least three years. If you die within the first three years, it is all subject Inheritance Tax. After that, that rate of tax 40% gradually starts to fall, only on the excess above that £325,000 though. It does mean, again, you can still gift larger amounts and the tax will gradually reduce.

It is obviously a complex area; you need to assess your personal situation through financial advice to assess whether that is going to be an option for you.

Emma Knights
Most definitely. We have talked about what the allowances are and we have said and hinted that there are lots of different things you can do to mitigate that. What are those things? Tell us a little bit more about what you can do to help with that?

Vince Keen
From the point of view of reducing the value of your estate, then gifting is an obvious one. So, we have covered that. Another area is using trusts, and some people may be familiar with this, or heard the terminology about, ‘I can put money into trust’, or ‘what does that really even mean?’. Trusts are often used as a way of sheltering assets to protect them for future generations and beneficiaries. It is effectively like a legal agreement, where you will have this money or your capital put into a trust, where you have trustees who then look after that on your behalf. In the event of your death, they can distribute that money out to your beneficiaries.

Now, the tax treatment, we will come on to that in a moment, but it is the same for most, the same seven-year rule will apply. It does then give greater flexibility with regards to that the money is now ring fenced demarked, in that trust, there is a wide range of options where you can invest that money. Crucially, you will no longer be able to access the money in that trust, money is now owned by the trust. If you are not keen on necessarily gifting the money directly to beneficiaries now, we can be talking younger grandchildren or whatever that may be. This is a way of actually still doing the planning, still having some control over when they may receive the benefit of that in the future.

Emma Knights
It is kind of giving you the control to look after that money for somebody else, but you are giving up the benefit of it for yourself, and that’s what’s helping you to get that IHT relief for it.

Vince Keen
Yes, absolutely.

Emma Knights
So, there are a few different types of trusts and I know they are very complex, I do not want us to go into too much detail and blow anybody’s mind. But tell us a little bit about the different types of trust and what they are kind of used for.

Vince Keen
Yeah, as I keep saying, and I will keep repeating this, so apologies, that this is a complex area so it is important to get the advice to consider all the different options, we will just cover a couple of the key ones.

Absolute Trusts, Bear Trust as they’re known, is probably the most basic type of trust. This is where you put the money into the trust and you know specifically from the outset who you want that beneficiary to be. It is similar to making it an outright gift but you have got this protection of the trust around it. It means then there is no tax on that trust. If you survive seven years, it will be free of inheritance tax, but they can be quite rigid and not particularly flexible. Legally, the beneficiaries of those processes can become entitled to them if they have got mental capacity or they are aged over 18. It does have other implications with that kind of trust, but it is a very simple kind of trust arrangement.

Now, Discretionary Trusts give much greater flexibility. This is often used where you have got a range of beneficiaries or several beneficiaries who might want to benefit from this trust. You appoint the trustees, so these are the people who are going to look after the money in the trust on your behalf. They are responsible for not just managing the money within the trust, but also distributing that out and paying that out to the beneficiaries. They do have the discretion to decide where that is going to go, it will obviously be done in line with your wishes, but hence the name Discretionary Trust, because it is not a clear cut, ‘This is going to A, this is going to B’ etc.

Emma Knights
This person is definitely entitled to this money as such.

Vince Keen
They have much more flexibility, but they are more complicated when it comes to the tax side.

Emma Knights
Most definitely. So, give us a little overview.

Vince Keen
I am trying to keep this as simple as possible. If you are investing small or gifting smaller amounts into a trust, it is unlikely there will be any tax on putting that money into trust. If however, the gift is above £325,000, you could pay what is called an entry cost of up to 20%. So, firstly, there is Inheritance Tax potentially on the gift into the trust itself. Once the money is in the trust, every 10 years, there is then an additional potential for IHT, if it is above those allowances, then eventually, when someone exits the trust, which will be on the event of death. It is not simple; the rules have changed on this a few years ago now. It does mean for a lot of people, they will potentially limit the amount that they would want to put into that type of trust, because of the ongoing tax that may not be favourable.

Emma Knights
Most definitely. I think it is really important to say as well, that legislation changes all the time. Although these are the things that we are telling people today, actually, that could change at any time. Again, it is really important to keep taking advice and making sure that you keep on top of those things. So, if things do change, you know how your circumstances are going to be affected in future.

Vince Keen
Yeah, I mean, we saw that many, many years ago now. But in the past, your £325,000 allowance when you died, if you hadn’t used it, it is lost. Then the rules change that if you were married, that could transfer over to your surviving spouse, so they get the combined total of those. For many that was a big potential benefit and you have just got to then plan accordingly and adjust for that. Everything we are talking about today is based on the rules now. They could change in the future. So again, it is important to stay on top of all.

Emma Knights
This is definitely mind blowing, I do not know how you keep up with all this.

Vince Keen
The one thing I will just mention here is that there are other types of trusts, which are definitely more financial investment related. What I mean by that is there are certain types of trusts where, for example, you can still retain access to some of your capital. The Inheritance Tax premium of those is maybe not as favourable. Where you are keen to use a trust as that route, but still want to retain access to some of your capital, it is possible.

Likewise, there are other types of trusts where you can, from the outset, have a regular withdrawal pay to use like a form of income. Even though you cannot touch the capital, you can still benefit from the income from that trust. So again, stressed again, I recommend getting advice.

Let’s see what type of arrangement suits you best, trusts are probably one of the most tried and tested routes to addressing your Inheritance Tax for people and have been around for for many, many years.

Emma Knights
Definitely. I think whenever you hear about the rich and famous, a lot of them, you hear that they have a foundation or a trust or something and quite often, those things have been implemented for them to help with their IHT planning. It just shows that people with a lot of money do tend to use them. It is not necessarily just because they have a lot of money, it could be beneficial to people with smaller amounts, depending on what they are looking to achieve.

Vince Keen
Yes, good point, and something I should have mentioned earlier, we are talking about the annual gifting allowance and stuff. If you are making gifts to charities, universities, political parties, if you have a will to do that, those gifts are exempt from Inheritance Tax. One other rule change that was introduced a few years ago now was in the event of your death, where I have mentioned that you will pay tax at 40% on that excess above those allowances, if you’re leaving more than 10% of the value of your estate to charity, that tax rate comes down from 40% to 36%. So, if you’ve got that desire within this, that will reduce the overall rate so there are other options of with this depending what your plans are.

Emma Knights
I think you just adding those bits in just shows the level of complexity in this area, as to why it is so important to take advice and then look at your situation to make sure that actually, ‘am I doing the right thing or the wrong thing here?’ and ‘is there something better that I could be doing to make sure this is as efficient as it could be?’

Vince Keen
Well, if you put Inheritance Tax into Google, millions of pages will come up with bulks of information, and because of that, it can be quite mind blowing. So, talking to specialists who can then talk to you and guide you through all of that. It is just being aware of what your options are.

Emma Knights
Definitely. I think it is really interesting when you go and see clients as well and speak to them and they tell you what their understanding is, because they’ve been on Google, and they’ve read these things. It’s incredible how people interpret all of these rules in slightly different ways, which to them, they think they’re doing all this planning, because this is exactly what Google told me to do, and I know it’s right. Interpreting it just slightly differently, can have a huge impact on what the resulting tax bill might be.

Vince Keen
Absolutely, and there is lots of jargon out there. So, it is trying to piece through all of that as well to think like, actually, what does this even mean in English? So, it does not make it simple.

Emma Knights
Perfect, so that’s trust. That is one thing that you can use to try to do some Inheritance Tax liabilities. I know, life insurance is another area. Tell us a little bit about how that would tend to work?

Vince Keen
Absolutely. Another option is effectively to take out a life insurance policy where, in the event of your death, it will pay out a lump sum that can be used to pay the tax. So in essence, what it doesn’t do is reduce the amount of Inheritance Tax that’s going to be paid in the event of death. But it’s a different way of paying for it.

Emma Knights
It is almost providing the means to pay that tax bill, you haven’t got to find that money as such to pay it.

Vince Keen
Yes, absolutely. So depending on your age, and your health, because often these go through kind of an underwriting process. For certain individuals, this won’t be relevant, because it will be very expensive. But for others, especially for younger people were thinking due again, it could be years away before I’ve got to really insist. But if I died unexpectedly, then would it be a problem, so insuring against it, can help towards that. Going back to something I mentioned earlier, it is important that those policies are written into trust, because otherwise it will pay out into your estate and compound the problem.

Emma Knights
Just make it all worse.

Vince Keen
If you’ve got, going back earlier, that £80,000 Inheritance Tax liability on there, if you’ve taken out an insurance policy to pay out £80,000, when you die, that money into trust may be used to pay the tax. Yet, it doesn’t impact the residual value of your state and your assets. There are different types of insurance policy that you may want to consider. For someone who has made gifts where it’s going to take seven years to be outside of your estate, one route is to take out an insurance policy that’s for a fixed term of seven years to cover that liability during that time. And then another type of insurance is what we call ‘whole of life’. As the name suggests, it lasts all of your life as long as you’re paying the premiums. So again, it can be done that way, if you’re married, often they’ll be set up, so it pays out when the second person dies. It’s kind of on the second death, when the Inheritance Tax is going to come into play. Again, it can be a useful way to mitigate that at that time. Again, just to stress, it doesn’t solve Inheritance Tax.

Emma Knights
Doesn’t get rid of the problem.

Vince Keen
No, but it’s another way and it could be quite cost-effective way to cover.

Emma Knights
Definitely. So, we have talked about a few different types of products. I know your area of expertise isn’t necessarily in those areas. BlackFinch actually do some slightly different things. So, do you want to tell us a little bit about what BlackFinch do, what the products are that you have available and how they tend to work with regards to IHT?

Vince Keen
Sure, so BlackFinch offer a range of solutions that invest in shares that qualify for something called Business Relief. This was a tax incentive introduced by the government over 40 years ago, back in 1976. I’ll tell you more about that in a moment.

What these solutions offer is, compared to the more traditional kind of seven-year route to address inheritance tax, if you invest in these types of investments, they will be exempt from IHT after two years. You need to be holding out at the time of your death, but it is potentially a faster way to address your Inheritance Tax. They are just investments, so this doesn’t involve trust and doesn’t involve gifts. That also means you can retain access to your capital should you need it in your lifetime. What you take out of it, is put back in your name. What remains in the investment at the time of your death, if it’s been more than two years, then you would then save Inheritance Tax like it.

It is giving you much more control over your own money and you can still access it, compared to some of the other solutions we’ve talked about where you’re giving up either access to capital or the income or both. Whereas this, you’ve kind of got more flexibility to use it how you want to. Absolutely, caveat that is subject to being able to get access to it to provide that, which can’t be guaranteed. However, it is something that we’ve seen, evolve and develop over the years where more and more people want to address IHT, but also want to kind of have their cake and eat it. In other words, we want to still retain access, should we need it.

So, just a bit of background to business relief, when it was first introduced, it was primarily aimed at small business owners who would run their limited company, their trading company and in the event of their death, what the Government’s keen not to happen is that the subject of Inheritance Tax forced businesses to close and sell. So, it was a way of passing that business on to beneficiaries without the impact of Inheritance Tax.

Now, over the years, that’s gradually been relaxed, and extended to lots of other areas. And there are certain types of shares and companies that qualify for this, which we’ll come on to in a moment. But, it now enables anybody to invest in shares in these types of companies, and still benefit from that tax break of holding it for at least two years at the time of your death, it will be 100% exempt from inheritance.

Now, the two main types of area which you can invest in, firstly, will be shares on the alternative investment market. I’ll explain a bit more about that in a moment. It’s the smaller company stock market, that sits behind the main stock exchange. Now, AIM first launched over 20 years ago, and there’s approximately 1,000 companies listed on AIM, so if you’re investing in the right kind of company, because not everything qualifies that you’re going into a list of trading companies, it basically means that you’re qualified for this route. So that is one route.

The other route is going into companies that are just not listed on a stock market. So, I will refer to those as unlisted companies. They have to be a trading company, and the important thing here is they have to be UK based trading companies. That’s why the government kind of reward investors, if you like, well this tax break is supporting the UK PLC.

So, over the past 15 years or so, providers such as BlackFinch, have therefore developed a range of solutions that invest in these areas. There’s a broad range of different kinds of solution and provider out there, so we’re not the only provider that does this kind of stuff. Therefore, it can be something which is going to give clients an attractive IHT benefit, as well as kind of retaining access to.

Emma Knights
It’s kind of giving the retail investor access to these things where normally they probably wouldn’t have access to these without a product such as yourself.

Vince Keen
Absolutely, and to stress again the importance of getting financial advice because they won’t be suitable for everybody. To come on to the key risk warnings, we have to add in there at the end. The two different strategies, there are two really distinct differences between the type of solution. So, I have mentioned AIM. Providers such as BlackFinch will offer an AIM portfolio service, where we invest you in a diverse portfolio of say, 20 to 40 plus companies, with the potential for significant capital growth over the medium to long term. But they are high risk because they are smaller companies, and therefore they will be more volatile. Another example there of how the rules have gradually relaxed in 2013, the government then allowed those shares to be held within an ICER wrapper. So there is a common myth that ISAs are free of Inheritance Tax.

Emma Knights
I have heard that one before.

Vince Keen
Because they’re tax free, so they grow tax free. The income they pay is tax free, but other ICAs would still be subject to Inheritance Tax on them. We now offer an AIM Inheritance Tax ICA. So, it means you can access the AIM portfolio within that ICA wrapper, still benefiting from tax free growth and tax-free income, but also then sheltering the money from Inheritance Tax in the event of death after two years.

The alternative route, I have mentioned AIM portfolios, longer term growth potential, but more volatile. We also offer a solution where the focus is very much around preserving wealth, with steady, predictable returns. What I mean by that is that we’re targeting returns on these solutions are kind of between 3% and 5% a year. The idea is to then just take away that volatility, so clients can see steady returns, still retain access to the capital that they need it. Ultimately, we have to make sure it’s qualifying and benefiting business. So how do we do that?

Emma Knights
Well easy, obviously, the sounds of it.

Vince Keen
We are invested here in trading companies, but they will be doing certain things. For example, one of the underlying trading companies we will invest in is a renewable energy business. So, within there, we now have a diverse portfolio of solar farms and wind farms around the UK on the basis that they are designed to deliver those steady predictable returns, and therefore, still deliver the tax break, and obviously be attracted to certain types of investors.

They’re still going to be regarded as and all these investments will be regarded as high risk investing in aim shares and unlisted companies. At the same time, obviously our focus for that particular solution is definitely to try and mitigate as much risk where we can to deliver those steady predictable returns. Wide range of options but for both the key headline benefits are exempt after two years, you retain access to control. They are relatively simple, because they are just investments it doesn’t involve trusts or the complexities of trusts or insuring against that. Again, that could be something that does put some people off.

Emma Knights
Definitely, so you’ve given us a good overview of several different types of ways to mitigate Inheritance Tax. I know you’ve got some important other things that you just want to add, as well, just to make it clear that obviously everybody does need to take personal advice, everybody’s situation is completely different.

Vince Keen
Absolutely. It’s just important to mention some of the key risks with these types of investments that I’ve referred to what BlackFinch offer. I’ve already mentioned AIM shares and investments into unlisted companies that will be regarded as high risk. Capital is at risk, you could get back less than you’ve invested. It could take some time to access your capital. Despite the fact that we have always been able to provide that regular liquidity so people can access it, it could take a while, and that tax rules may change in the future. It will not be suitable for everybody. Again, I’ll finish off on my key message all the way through this, it’s really important to seek professional advice from a specialist advisor in this area, so they can assess your circumstances to see how this may benefit for you.

Emma Knights
Thank you so much for sharing all of that information with us today, Vince. I know lots of people will have lots of questions now about all different areas of Inheritance Tax. But if anybody wants to contact us as well, you’re more than welcome so we can always answer any of your questions. Thanks again, Vince.

Vince Keen
You’re very welcome and thank you for having me.

Emma Knights
Thank you.