Navigating Inheritance Tax – The Smith Family

The Family’s Financial Landscape

At the time of review, the Smiths’ joint estate was valued at approximately £1.5 million, comprising:

• £300,000 in their family home
• £325,000 in shares (with significant capital gains)
• £889,000 in cash and other liquid assets

They expressed a desire to gift £500,000 to their three children, divided equally, as part of their estate planning.

The Challenge

Without any planning, their estate would face an estimated IHT bill of £225k on second death. The couple wanted to explore ways to reduce this liability, ideally without triggering Capital Gains Tax (CGT) or compromising their financial security.

Understanding the Rules

We walked the Smiths through the key IHT allowances:

• Nil Rate Band (NRB): £325,000 per person, transferable between spouses
• Residential NRB (RNRB): £175,000 per person, available when passing the home to direct descendants
• Gifts Out of Income: Regular gifts from surplus income are immediately exempt from IHT

With these allowances, up to £950,000 of their estate could potentially be passed on tax-free on death.

The Solution

Three main strategies were considered:

1: Gifting Shares and Cash Directly (PETs)

This approach involved gifting both shares and cash directly to the children. While this would reduce the estate value, it came with a CGT liability of approximately £47k due to the gain on the shares. The gifts would be exempt from IHT if the Smiths survived for seven years.

Pros: Significant IHT reduction
Cons: Immediate CGT cost

2: Gifting Cash Only (PETs)

To avoid CGT, the Smiths could gift only cash. This would still reduce the estate to £950,000, fully covered by the NRB and RNRB, and avoid any immediate tax charges.

Pros: No CGT; simple execution
Cons: Reduces liquid assets; shares remain in estate

3: Trust Strategy (CLT + PET)

A more sophisticated route involved transferring the shares into a discretionary trust (a Chargeable Lifetime Transfer or CLT) and gifting cash directly. By keeping the value of the trust transfer within the NRB, no IHT would be due at the time of transfer. Crucially, gift relief could be claimed to defer CGT on the shares.

Pros: No immediate tax; future growth of shares outside estate
Cons: Ongoing trust administration; potential future IHT charges on trust assets

The Value

After careful consideration, the advisers recommended a combination of Option 2 and Option 3, along with ongoing gifts out of income.

This strategy would:

• Keep the estate below the £950,000 IHT threshold
• Avoid immediate CGT or IHT liabilities
• Preserve flexibility and financial security for the Smiths

We advised the couple to review their income and expenditure to ensure sustainability and to consider involving their children in the planning discussions. They also were advised to keep strong written notes of their gifts should an enquiry ever be raised by HMRC.