IHT, Business Relief and the £2m Taper
George, 71, was widowed in 2012; his wife left her entire estate to him. His estate is currently worth £2.35 million: a house worth £950,000, AIM-traded trading company shares worth £700,000 that have qualified for business relief for six years, a GIA worth £600,000 and £100,000 cash. His will leaves the house to his two children. He made a potentially exempt transfer of £150,000 to his son three years ago. His income is £70,000 a year from pensions and dividends, and he spends £55,000. He wants to reduce inheritance tax (IHT), but is risk-averse and worried about future care fees. He is considering giving £500,000 to his children now, buying a whole-of-life policy, or simply spending more. He has not used this year's annual exemption.
1. Calculate George's current IHT exposure and explain the effect of the prior gift.
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Estate and reliefs
Estate £2.35m less 100% business relief on £700,000 of qualifying AIM trading shares = £1.65m chargeable before nil rate bands. Check the shares genuinely qualify: trading company, not an excluded investment business, and two-year ownership satisfied.
Nil rate bands
George's wife left everything to him, so her unused nil rate band is transferable: £325,000 + £325,000 = £650,000.
The residence nil rate band is tapered where the estate exceeds £2m. The taper test uses the value before reliefs such as business relief. The estate is £2.35m, i.e. £350,000 over £2m, so the residence nil rate band is reduced by £175,000 and is nil. The transferable residence nil rate band is also nil. Business relief does not restore it.
Prior PET
The £150,000 PET made three years ago is within seven years of death, so it becomes chargeable and uses the nil rate band first. Remaining nil rate band for the estate = £650,000 − £150,000 = £500,000. Taper relief does not help because the PET itself bears no tax; it has merely absorbed nil rate band.
Tax
£1.65m − £500,000 = £1.15m × 40% = £460,000. If George had made no PET, the tax would be £400,000. The prior gift has therefore increased the estate's tax by £60,000, because it used nil rate band that would otherwise have sheltered the estate.
2. Evaluate the proposed £500,000 gift and quantify the saving if George survives seven years.
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The arithmetic if he survives seven years
Estate falls to £1.85m. The prior £150,000 PET is then also outside the seven-year period (it is already three years old), so it drops out. The estate is below £2m, so the residence nil rate band is available: £175,000 plus the transferred £175,000 = £350,000. Taxable estate = £1.85m − £700,000 business relief − £650,000 nil rate band − £350,000 residence nil rate band = £150,000 × 40% = £60,000. The saving against the current £460,000 is about £400,000.
But the gift is not free
- He must fund £500,000 from the GIA and cash. Selling £400,000 of GIA assets may trigger capital gains tax; a gift of shares in specie is still a disposal at market value. Do not assume holdover relief is available.
- He loses the income from the gifted assets. His surplus income is only £15,000 a year, so the gift may crimp his lifestyle.
- If he needs care, the local authority may treat the gift as deliberate deprivation of assets. He should retain enough to fund care.
- He loses control, and the children may divorce or predecease him.
- He must survive seven years for the full saving. If he dies within seven years, the gift becomes chargeable and taper relief only reduces the tax on the gift, not the estate tax.
Better sequencing
Use this year's £3,000 annual exemption and consider regular gifts out of surplus income. Gift a smaller amount that preserves his care fund, and consider whether the AIM shares, which already carry business relief, are the better asset to give. Do not let IHT drive him into a risk profile he cannot tolerate.
3. Compare the whole-of-life policy and spending options, and identify the risks in relying on business relief.
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Whole-of-life policy
A whole-of-life policy written in trust can provide about £460,000 to pay the IHT bill without forcing a sale of the house or AIM shares. Premiums are payable for life and depend on health and age. If structured as normal expenditure out of income, premiums may be exempt from IHT, but that requires a regular pattern and genuine surplus income. The policy is not an investment; if the estate falls, the cover may be excessive. Review indexation and trust wording.
Spending more
Spending capital or income reduces the estate and improves his quality of life, but he is risk-averse and worried about care. A spending plan that uses some of the £15,000 annual surplus, plus perhaps £50,000–£100,000 of capital over time, may be better than a large irreversible gift. It also reduces the risk of deprivation-of-assets challenges.
Business relief risks
The £700,000 AIM holding is already a concentrated, volatile position. Business relief depends on the company remaining qualifying and the shares being held for two years; a change of trading status or a takeover can affect relief. AIM shares can be illiquid in stress. Do not increase the holding simply for tax. If he needs income and security, a diversified portfolio may be more suitable even if it is less IHT-efficient.
Other points
Consider a charitable legacy: leaving 10% of the baseline estate to charity can reduce the rate to 36%, but the children receive less. Review the will, the transferable nil rate band and the downsizing addition if he sells the house. Keep care-fee liquidity of at least two to three years' costs.