Inheritance tax – what you need to know
As with the making of a Will and other estate planning considerations, time spent understanding your estate’s tax liabilities and planning for them will give you peace of mind, writes Nicola Waldman.
Inheritance tax is a major source of worry for many people who are understandably concerned that the Government will take the lion’s share of the money in their estate, leaving future generations with only a fraction of the wealth they worked hard to create.
Inheritance tax is something you should be thinking about if you have assets worth more than the current inheritance tax threshold of £325,000. With the huge rise in house prices in recent years, even those who don’t consider themselves wealthy may be affected.
Currently, the first £325,000 of your estate is taxed at 0%. This is known as the ‘Nil-Rate Band’ and is not subject to inheritance tax. The threshold is revised by the Government from time to time, however the current rate came into force in 2009 and is not expected to change until the tax year ending 5th April 2021. Any change will be announced in the Budget each year.
Any assets over and above this threshold are taxed at the rate of 40%. So, for example, if you have a total estate, including the family home, worth £500,000 then you will pay 40% tax on £175,000. This works out at a hefty tax bill of £70,000.
So how can you plan for inheritance tax on your money, property and possessions? It is a complex area but there are things you can do to help minimise the amount of inheritance tax your estate will pay.
Estates left to husbands, wives and civil partners
One thing to consider is who you are planning to leave your estate to. If you are married or in a civil partnership and plan to leave any part of your estate to your partner then what you leave them will not be subject to tax. For unmarried couples who are not covered by this exemption, they might want to consider formalising their partnership through marriage, if for no other reason than to avoid a hefty inheritance tax bill.
An alternative option is to take out a life insurance policy to cover the tax bill, however this can be costly for those who are older or who have pre-existing conditions.
Exemptions for residential property left to descendants
If you are planning to leave your property to your descendants then changes that came into force earlier this month will help you reduce inheritance tax. Each individual can claim an additional tax free allowance when a residential property is passed on death to a direct descendant. This new tax allowance will rise by £25,000 per year from £100,000 in the current tax year to £175,000 by 2020, allowing a married couple to pass on up to £1m tax free (including their nil rate bands), where the family home is included.
The new benefit tapers off for those with estates valued at over £2m and will not apply to those who do not have children or other issue, or to buy-to-let or second properties.
If you had a will drawn up in the past, designed to minimise inheritance tax liabilities through the use of trusts, you may need to revise it as the changes won’t apply to properties held in many types of trust. This will include gifts over to grandchildren subject to them reaching a specific age, which is also a form of trust.
Those who had planned to split their assets between descendants and charities, for example, may also need to revisit their wills to ensure that they are not in danger of losing the exemption as a result of not leaving the entire family home to descendants.
Making lifetime gifts
It is possible to reduce the size of your inheritance tax bill by giving away some of your assets before you die. Any assets you give away at least seven years before you die are exempt from inheritance tax. It is possible to give away up to £3000 each tax year without it being liable to inheritance tax at all. If you don’t give all of it away for one year, you can give away the balance with another £3,000 in the next tax year.
Making donations to charity
Gifts to charities and other qualifying organisations such as museums, universities and political parties are not liable for inheritance tax. If you give 10% of your estate to charitable organisations by will, then you can reduce any inheritance tax on the balance of the estate from 40% to 36%.
Setting up a trust
When you put money or property in a trust, provided certain conditions are satisfied, you no longer own it. This means it should not count towards your inheritance tax bill when you die.
This is a complex area and there are different types of trust to consider, often involving parents or grandparents putting assets into a trust for the benefit of their children or grandchildren. It may be an opportunity to pass cash, property or business assets down a generation without giving up total control. The trust has to be set up with trustees whose role is to manage the assets for the benefit of those who will ultimately inherit. Trusts may be created during your lifetime or by will.
As with the making of a will and other estate planning considerations, time spent understanding your estate’s tax liabilities and planning for them will give you peace of mind. By ensuring you understand the implications of inheritance tax rules and making the necessary provisions to minimise the bill that loved ones might face, you can provide certainty and financial security for those you leave behind.
The article was first published in the Final Choices magazine, April 2017.