Inheritance Tax Planning
What is Inheritance Tax Planning?
Inheritance Tax Planning is about putting proactive planning in place to make sure your Estate is held and passed down to your beneficiaries in the most tax efficient way possible. Family wealth is often subject to Inheritance Tax as it passes down each generation, eroding that wealth for you and your loved ones over time.
However, Inheritance Tax is largely a voluntarily tax, which can be legitimately mitigated, meaning you no longer have to worry about losing 40% of your wealth on death.
All of this is achievable with the right expert guidance, utilising Trust Laws, and true Estate Planning.
Trusts have been enshrined in English Law for Centuries and exist to protect your wealth so that the right money really does go to the right people, at the right time and then stays there!
What is Inheritance Tax?
Inheritance Tax is a tax paid on the Estate (the property, money, and possessions) of someone who has died.
What is the threshold for Inheritance Tax?
We each have an Inheritance Tax Allowance of £325,000, any assets above this threshold are normally subject to Inheritance Tax at 40% upon our death.
Your unused Inheritance Tax Allowance can pass to your spouse or civil partner, meaning that couple have a total Inheritance Tax Allowance of £650,000.
In addition to this, since 2017, the Residential Nil Rate Band Allowance has been introduced. This allows you to claim an additional £175,000 of tax-free allowance, if you give away your home to your children (including adopted, foster or stepchildren) or grandchildren. This means your Inheritance Tax threshold can increase to £500,000 or £1,000,000 for a couple. There are many pro’s and con’s to claiming this extra Inheritance Tax Allowance which you need to be aware of before committing to do this, so please make sure you take advice on this new legislation.
There is normally no Inheritance Tax to pay if either:
- The value of your Estate is below the £325,000 threshold
- You leave everything above the £325,000 threshold to your spouse, civil partner, a charity, or political party.
Even if the Estate value is below the threshold, you will still need to report it to HMRC through Probate.
What are the current Inheritance Tax rates?
Your Estate is worth £700,000 and your tax-free threshold is £325,000 + £175,000 of Residential Nil Rate Band Allowance = £500,000. The Inheritance Tax charged will be 40% of £200,000 (£700,000 minus £500,000) = £80,000 of Inheritance Tax to be paid.
The Estate can pay Inheritance Tax at a reduced rate of 36% if you leave 10% or more of your Estate to charity in your Will.
How can I reduce the level of Inheritance Tax I pay?
There are many steps you can take to reduce or mitigate your Inheritance Tax liability and protect your legacy for your loved ones and beneficiaries. Here are some steps you can take. You should seek professional advice to understand which one, or combination of steps, can minimise your liability.
Ensure you have a valid Will
Having a valid Will is the critical starting point to Estate Planning. Making a Will is one of the most important things you can do to ensure your Estate goes to who you want and that your wishes are carried out.
If you do not have one, you need to make one. If you have one, it must be reviewed to ensure it is up to date and valid.
Even if your Will is valid, you might need to act. For example, you might need to revisit your Will to benefit from the new Residence Nil-Rate Band tax relief, which is only available if assets are left directly to descendants. Many Wills written prior to this new legislation coming into effect hold assets in Trust and you could lose out if your Will is not updated.
While a basic Will or a Will from an Online Will Writing Service is ideal for making sure your legacy goes to the people you choose, it is insufficient if your goal is true Estate Planning.
If you want to put Estate Planning in place, we strongly recommend you take professional advice to create a Will that makes sure your wishes are met and that they are crafted to be as tax-efficient as possible.
Many people set up Mirror Wills with their spouse or civil partner, which means that they leave their Estate to the other in the event of their death. However, it might make more sense to make a Will that transfers some assets to children or grandchildren after the death of the first spouse. It all depends on your circumstances and you should seek professional advice and guidance that is tailored to your unique requirements.
Insure against your Inheritance Tax liability
Life Insurance is an often underused, overlooked and yet remarkably simple and cost-effective solution to an Inheritance Tax problem.
Let us assume there is an inheritance tax liability on your death of £100,000, you could simply choose to take out a life-insurance policy for £100,000. As long as it is the right type of policy, paying into the right type of Trust, it will provide the money to your beneficiaries on your death so they can pay the Inheritance Tax from the life insurance proceeds and don’t have to find the money to pay the tax bill themselves.
Depending on your age and health, we often find that Clients pay far less in life insurance premiums than they ever do in Inheritance Tax.
Give your Assets away
You could choose to give some of your wealth away before death occurs. However, there are some important rules to be aware of.
First is the Seven-Year Rule which says that if you give away some of your wealth, then in order for that wealth to be outside of your Estate for Inheritance Tax purposes, you need to survive for seven years after the gift has been made.
Second is the Gift with Reservation of Benefit Rule. which says it must be a true gift. If you give some of your assets away, for example you sign your house over to your children before you die, then you cannot reserve some kind of benefit or use of that house. You would have to pay your children the full market rent value to continue living in the property and you cannot receive any of that rental back as a gift from your children. If you do, then the seven-year clock doesn’t even begin to tick and the value of your property or any money you have received will be counted back into your Estate for the purposes of Probate upon your death..
While giving away your wealth might seem an attractive solution to reduce an Inheritance Tax liability, it is vital to do this in a safe and secure way, such as using a Trust. Imagine giving it to your married daughter and then she goes through a divorce. The wealth she has received now forms part of her assets and can be taken into consideration when the assets are divided as part of the divorce process.
Inheritance Tax Investments
Investments can also be an excellent way to solve an Inheritance Tax problem.
The Government have a range of investments which they exempt from Inheritance Tax that you can choose to use.
These type of investments are not available from your high street banks or building societies, these are true investments into the market, so it’s no good just simply saying if a particular investment works for Inheritance Tax then you should put all of your money into it.
It is important that you take specialist investment advice from a specialist Financial Adviser. Whether that’s us or somebody else, it’s critical we make sure that any investment strategy meets ALL your investment needs, including what risk are you happy to take with your money, do you need access to capital, income or both, what growth are you expecting?
A specialist Financial Planner should be able to meet all those needs whilst also finding you an investment strategy that will be able to give you the Inheritance Tax exemption, saving you 40% tax at the same time.
Spend the kids Inheritance!
If you have an Inheritance Tax problem and you are happy that you have more money than you need to look after yourself for the rest of your life, you may want to start considering spending some of that wealth now, on things that you enjoy.
Whether that is booking another world cruise, some holiday of a lifetime or anything else that helps you to spend the money. Think of it like there is a 40% sale on permanently! Every time you spend £10,000 of your money, that’s £4,000 that won’t be going to the Inland Revenue.
If you have done everything in life you want to do, but still have more money than you need, then why not consider spending your wealth on whoever your beneficiaries are now.
Why do we wait to pass the wealth to the next generation when we die? We don’t get to see the amazing effect we’ve had on our loved ones with this wealth and for those of us left behind, it’s bittersweet, because yes, we’ve received the family wealth but we’ve also lost somebody we love at the same time.
But if we are going to give some of that wealth away before we die, it comes back to the earlier point about doing it safely and the best way to do that is through our Protective Family Trusts.
There are a whole range of different Trusts we can choose to use for our loved ones. Some examples would be an Education Trust. If you like the idea of paying for your children or grandchildren’s private school fees or higher education.
There is a Deposit Trust that is becoming far more popular these days with parents or grandparents wanting to help their loved ones get on the property ladder. It enables you to give them the deposit, but you can give it to them through a Protective Trust so that if their future relationships don’t work out then the deposit you gave to them is safe and stays with your loved ones. There is even a Mortgage Trust. If you like the idea of paying off your adult child’s mortgage for them.
With any of these gifts, as long as you survive 7 years, the gift will be outside of your Estate for Inheritance Tax purposes, saving 40% tax and the Trust will keep this gift safe and protected for your beneficiaries.
Can I give any of my wealth away without paying Inheritance Tax?
You can give a spouse or civil partner as much of your wealth as you like without any tax on Inheritance.
Each year you have an annual allowance which means you can give away £3,000 and that gift will not be subject to Inheritance Tax.
You can also give small gifts of £250 to any number of people each year.
Parents can give £5,000 to each of their children as a wedding gift. Grandparents can give £2,500 and anyone else £1,000.
Gifts of any size to charities or political parties, are also tax free. If a gift is regular, comes out of your income and does not affect your standard of living, any amount of money can be given away and ignored for Inheritance Tax purposes.
It is possible to make further tax-free gifts – potentially exempt transfers – but you have to survive for seven years after making the gift to get the full benefit of it being outside of your Estate for Inheritance Tax purposes.
If you pass away within seven years and the gifts are valued at more than the nil-rate band, taper relief will be applied. The tax reduces on a sliding scale if the gift was made between three and seven years earlier.
When is Inheritance Tax due?
Inheritance Tax must be paid within six months of your loved one’s death, and interest will start to be charged by HMRC thereafter.
Typically, the taxes on an inheritance will be taken out of the deceased Estate. Usually, the deceased will have appointed an Executor in their Will to take care of this. However, HMRC expect to be paid before Probate is granted and other than some exceptional cases, the beneficiaries have to make arrangements to settle the Inheritance Tax bill before they can receive their Inheritance and recoup the Inheritance Tax bill value.
If someone dies without a Will in place (Intestate), then the legal heir will have to designate someone to administer the Estate.
What if no Inheritance Tax is due?
If no Inheritance Tax is due, you will still have to report to HMRC and provide an Estate Value calculation. For this reason, the first thing to do when someone dies is to calculate the total value of the Estate. This is the role of the Executor or appointed Administrator.
How is Inheritance Tax calculated?
- Work out the market value of all the Estate’s assets and add them up. This exercise will give you the Estate’s ‘gross value’.
- Deduct any debts, such as unpaid mortgages, overdrafts, and loans, to find out the Estate’s net value. You will also need to deduct any tax relief you get on business assets and agricultural assets.
- Deduct the value of tax-exempt assets. This includes tax-free gifts, anything left to spouses, charities or other tax-exempt beneficiaries and anything gifted seven years or more before the deceased passed away.
- Deduct the current and available Tax-Free Allowances from the answer in step 3. You will have to pay 40 percent tax on anything that’s left over.
Talk to Redwood Financial for Advice
At Redwood, we bring our expertise in both Estate Planning and Financial Planning, to tackle your Inheritance Tax liability on both fronts. Bringing the two disciplines together, means our Clients have a more comprehensive understanding of all the different ways you can legitimately mitigate your Inheritance Tax bill and save you and your loved ones 40%.
FREE Wills & Trusts Webinars
To find out more we always recommend that you start by attending one of our FREE 40 minutes Wills & Trusts Estate Planning Webinars. This will give you a good insight into what is involved before you even embark on your Inheritance Tax Planning journey.