There was a time when Inheritance Tax mitigation was a discussion reserved for the rich and famous. Those days are long gone. It’s predicted that the number of families in the UK facing an IHT bill which hit a 35-year peak in 2017. The surge in house prices and inflation of other assets will be the biggest contribution to this. The government has provided some relief with the introduction of the “main residence nil-rate band”, however in reality more and more people will continue to be affected by IHT.
Inheritance Tax (IHT) is a tax on the estate of someone who has died, including all property, possessions and money. As a result is sometimes referred to as the ‘death’ tax.
Only a percentage of estates are large enough to incur Inheritance Tax, but as stated this is increasing yearly and you need to remember to factor IHT into your plans when you make your will.
There is normally no tax to be paid if:
• The value of your estate is below the IHT threshold of £325,000, or
• You leave everything to your spouse or civil partner, or
• You leave everything to an exempt beneficiary such as a charity
If the value of your estate is above the nil rate band (NRB) of £325,000; then the part of your estate that is above this threshold will be liable for tax at the rate of 40%.
For example: If your estate is worth £500,000 and your tax-free threshold is £325,000. The inheritance tax charged will be 40% of £175,000 (£500,000 minus £325,000). In this case, you could be facing a bill of £70,000.
The NRB is fixed at £325,000 until 2021.
The Residence Nil Rate Band (RNRB) – also known as the home allowance – has been introduced recently.
The government will make a list of all your assets and their value at the date of your death. This will include your home, other properties, possessions, money in bank accounts and any pay-out from an insurance policy. Any debts and liabilities will be deducted, for example; mortgages, credit card/gambling debts and funeral expenses.
With Inheritance Tax there is an important 7 year rule. Any gifts you may have made, whether it was to a family member or friend, within the 7 years prior to your death, will be included in your estate. Gifts are classed as money or assets, for example; cash, car or clothing.
If you have a Will, it’s usually the executor of the Will who arranges to pay the IHT. If you don’t have a Will it’ll be the administrator of the estate who does this. The IHT is normally paid from the funds of the estate, or from money raised by the sale of assets if there isn’t enough money to cover the bill.
Sometimes, the person who died will have left money in their estate specifically to pay the bill or may have arranged for a life insurance policy to cover the liability. Only once the tax and debts have been paid can the remaining assets of the estate be distributed.
Some gifts and property are exempt from IHT, such as some wedding gifts and agricultural property. Remembering the 7 year rule anything you have given away in the 7 years before your death will be taken into account.
However there are a number of ways to try reduce your IHT or ensure you stay below the threshold:
• Leaving your estate to your spouse or civil partner
• Putting assets into trust for your heirs
• Taking out Life Insurance – the correct plan can provide your beneficiaries with enough money to cover your IHT early and releasing your estate to be distributed.
• Paying into a pension instead of a savings account
• Regularly giving away up to £3,000 a year in gifts – you can give away £3,000 worth of gifts each tax year without them being added to the value of your estate.
• Leaving money to charity – IHT reduces to 36% if you leave 10% of more to charity.
There are a few reasons why you might want Life Insurance to help pay your IHT. If you think there might be an Inheritance Tax liability to pay when you die and want your family to inherit your estate in full without it being reduced or to protect your home from being sold to pay for the IHT bill you’d want a lump sum to be paid out on your death to cover this. You may have made gifts to friends and family in the last 7 years which are likely to be counted towards your IHT bill.
Whilst life insurance will provide a pot of money to pay any IHT bill, it does not actually reduce the potential tax. One option to mitigate assets and reduce the potential charge would be to set up a Trust and move money from your estate into it. The Trust is a separate legal entity and once it has been in existence for 7 years the assets that it holds will no longer be part of the person’s, that gifted the money to the Trust, estate.
A Trust can be a great way to move money out of the estate without losing complete control of it. A Trust has Trustees, who are the people that make the decisions on what happens to the Trust’s assets. Usually those that are gifting the money to the Trust will be the Trustees with potentially others to assist with eventually winding the Trust up after death.
A Trust can be a good way of passing money to the different generations of a family as there can be multiple beneficiaries, some Trusts will detail specific beneficiaries others allow the Trustees to decide and are therefore more flexible.
Whilst a Trust can be a good way to move money outside of an estate, not everyone has the luxury of time and is able to wait the necessary 7 years. Also if a person is acting as power of attorney it is very unlikely that they will be allowed to carry out inheritance tax planning. In these instances there is an option for investment that uses Business Property Relief rules and would allow assets held within it to obtain 100% IHT relief after only 2 years, a considerably shorter period of time. This type of investment also allows the individual to have full control over the money, being able to decide to have capital growth and/or income and if necessary being able to cash it in.
Inheritance tax can be expensive but it is a tax that can be reduced or even wiped out if you get advice. There are many legal ways to do this you just need to know what is best for you and most importantly don’t leave it too late.
If you have any queries or questions about Inheritance Tax, please leave a comment or contact us here.
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