Inheritance Tax could potentially cost your loved one’s hundreds of thousands of pounds, yet it is possible to dramatically reduce this or even to pay none at all. Brona MacDougall our Senior Tax Manager provides you with some superb advice for effective IHT planning.
Inheritance Tax (IHT) is a tax on the estate of someone who has died, including all property, possessions and money. There is normally no tax to be paid if the value of your estate is below the IHT threshold of £325,000, or if you leave everything to your spouse or civil partner, or if you leave everything to an exempt beneficiary such as a charity.
For example, 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%. So, if your estate is worth £525,000 and your IHT threshold is £325,000, the tax charged will be on £200,000 and the tax would be £80,000.
The Residence Nil Rate Band or ‘home allowance’
The Nil Rate Band (NRB) is fixed at £325,000 until 2021 but the Residence Nil Rate Band (RNRB) – also known as the home allowance, has been introduced recently. The home allowance is on top of the NRB and to be eligible you must pass your home or a share of it to your children or grandchildren.
This includes step-children, adopted children, foster children but not nieces, nephews or siblings.
Provided certain conditions are met, the home allowance gives you an additional allowance to be used to reduce the IHT against your home. The home allowance is currently £125,000, but it will rise incrementally to reach £175,000 in 2020/21 and in line with the Consumer Price Index thereafter.
If you think your estate might have to pay Inheritance Tax, there are five things that you can do to reduce the amount of tax that is payable.
Make a gift to your partner
You can beat Inheritance Tax by giving away assets, setting up a trust or changing your will. But do make sure that you pay attention to the legal details and tax consequences.
If you’re married or in a civil partnership, you can give anything you own to your spouse or civil partner (unless your spouse was born outside the UK, in which case the amount you can give away might be limited), so your estate won’t have to pay Inheritance Tax on what the gift is worth.
There are different rules if your spouse or civil partner’s permanent home is outside the UK.
Do make sure you take advice before doing anything.
Give to family members or friends
If you give something to a friend or a family member who is not your spouse or civil partner, so that you no longer get any benefit from it, the value of the gift will still be included in your estate for Inheritance Tax – but only for seven years.
If you give one of your children some money, and you live for a further seven years, it won’t be taken into account when calculating the Inheritance Tax liability when you die. You can give away limited amounts every year and not have to pay Inheritance Tax. You can give away up to £3,000 a year and you can give away money to your children and grandchildren when they get married. Do be aware that there might also be Capital Gains Tax to pay on certain assets that you give away in your lifetime.
Put things into a trust
If you put some of your cash, property or investments into a trust (which you, your spouse and none of your children under 18 years can benefit from), they will continue to be included in your estate for IHT purposes, but only for 7 years.
For example, you could set up a trust for your adult children, to pay for your grandchildren’s education, or support a family member with a disability. You can set up a trust right away or you can establish one in your will. There might be Capital Gains Tax consequences if you transfer certain assets into a trust in your lifetime, but there will be no liability to Capital Gains Tax if you establish a trust in your will. Bear in mind that some types of trusts are subject to their own tax regimes and the trust might have to pay Inheritance Tax themselves. Also, trustees are likely to be liable for Income Tax at a rate of 45% and capital gains tax at 28%.
Again, the rules around trusts are complicated so you must take advice from an expert.
Leave something to charity
Anything you leave to charity is free of Inheritance Tax so it can be a useful way of reducing your Inheritance Tax bill, whilst also benefiting a good cause. And if you leave at least 10% of your estate to charity, it will cut how much Inheritance Tax is due on the rest.
The rate at which Inheritance Tax is calculated is 36% rather than 40%. This rate is set against the balance of the estate to the extent that it exceeds the available nil-rate band. Although it can be reduced or eliminated by certain gifts made in a person’s lifetime. This might not be a huge saving, but it will reduce the share of your estate that goes to HMRC, whilst your favourite charities also benefit at the same time.
Take out some life insurance
If you take out a life insurance policy, it won’t reduce the amount of Inheritance Tax due on your estate. But the payout might make it easier for your surviving family to pay the bill and it could mean that they are able to prevent the family home from being sold. But if you do this, make sure that the life insurance payout goes into trust, if you don’t it will make your estate bigger and it will have to pay more tax.
Without careful financial planning, HMRC could become the single largest beneficiary of your estate following your death. It is undoubtedly a complex area and JRW can provide all the advice and assistance that you need to help you to minimise IHT with clever and appropriate planning.