Give away the family home to reduce IHT!

The issue

Hopefully quite a few readers have reacted to this title by saying (or thinking!) something like “You can’t get a family home out of your IHT estate if you still live in it because this will be caught by the gift with reservation of benefit rules and so it will stay in your estate for IHT purposes”. This statement would be broadly true but there are some exceptions. One exception is where the gift recipient also lives in the house and is gifted an undivided share of the property and does not then pay more than their share of expenses. The other exception (which I want to focus on here) is where the house is gifted and then a market rent is paid for life to live in the property.

Example

Edgar is 75 and owns a property worth £3m in London. He has been told that if he gives this to his son Edmund and survives seven years then it will be outside of his estate for IHT as long as his son charges him a market rate of rent. This has been determined at £10,000 per month (in the real world this would increase over time but for simplicity of the calculation, this is ignored). Let us assume that Edgar dies exactly seven years after making the gift when the property is worth £3.75m. Let us also assume that Edmund pays 45% tax on any rental income he receives from Edgar. Edmund is Edgar’s sole beneficiary.

The key tax consequences as a result of this gift are as follows:

1. Edgar will have paid £840,000 of rent which will have triggered tax of £378,000 in Edmund’s hands (cost).
2. The rental payments will have saved IHT of £336,000 which would otherwise have been due on the retained cash (benefit).
3. IHT of £1.5m will have been saved on the house (benefit).

The net benefit of this planning compared to doing nothing would therefore be £1.458m.

Using pensions

The above example makes this look quite attractive, but it implicitly assumes that Edgar has lots of surplus cash lying around with which to pay the rent. This may not be feasible in many scenarios. A few years ago pensions would have been the last port of call due to their IHT protected status, however, after 5 April 2027 pensions will be fully subject to IHT with beneficiaries then having to pay income tax on remaining funds. For many, it will make sense to draw down on pensions to pay the rent on the gifted properties. Although the pension income would be taxable, this is likely to be at much lower rates than the overall rates that a beneficiary would face on the death of the scheme member. It would add another cost/benefit number crunching analysis to the above scenario, however.

WSM’s view

The above example is quite simple, but the trouble with this kind of planning is that people do not know when they are going to die. However, it is possible to crunch numbers for all death date contingencies and these generally show that the costs will outweigh the benefits for an early death (because the house will still be in the estate for IHT purposes) whereas a later date tends to lead to significant savings (because the house falls out of the IHT net and has possibly grown in value). Taxpayers often reject this planning because it does not sit well with them to give away their main asset and then pay rent for the privilege of living in it . Plus, they also may not have the ready funds to pay the rent. With the potential requirement to somehow reduce the value of pensions, this planning is worth taking another look at. Those with expensive houses may want to take a cold, clinical look at the figures and then take a view on whether this is something that they are prepared to stomach.