It was Benjamin Franklin that once famously said “Nothing can be said to be certain, except death and taxes”. While there’s nothing any of us can do about the former, there are most definitely steps we can take to legitimately reduce our tax bills.
Record Inheritance Tax (IHT) receipts highlight the importance of planning your estate, with HMRC having collected record £5.1bn from IHT in the last 12 month: up on the same period last year. With the threshold at which IHT is payable having been frozen since 2010, the number of families paying IHT has increased by 160% between 2010 and 2017, with data from the Office for Budget Responsibility showing that that 40,000 families paid IHT in the 2016/17 tax year.
So the worry of Inheritance Tax is no longer a burden that only the very wealthy have to deal with. More and more families are now getting caught by IHT, largely but not always exclusively, due to rising house prices experienced over the past decades.
How IHT works
IHT is payable at a rate of 40% on the value of your estate above £325,000, or £650,000 if you’re married or widowed. Your estate includes the value of your home, minus your mortgage, as well as all your other possessions, such as your car, jewellery, antiques, art and so on. Many people assume everything they own will be worth less than the current threshold, but rising property prices have pushed more and more estates above the £325,000 threshold.
From 2017-18 onwards, there is an additional transferable main residence nil rate band of £100,000 (rising by £25,000 each year until 2020-21 and by CPI after that) available when a home is left to children or other direct descendants. However, not everyone will be able to benefit from the new allowance, as you can only use it if you are passing your home to your children or grandchildren. If you don’t have any direct descendants, you won’t qualify for the allowance.
Way to avoid leaving your family with a potential tax headache
The good news is there are a number of steps most people can now take to reduce their exposure to IHT, even if you don’t qualify for the family home allowance. Here are just a few examples:
Gifting: There are various allowances available which enable you to make gifts free of IHT every year
- You can give up to £3,000 away each tax year, so couples can give away £6,000 between them
- You can also give as many £250 gifts per person as you want each tax year, but you can’t give one of these to anyone you’ve already given your £3,000 allowance to
- Wedding gifts are also exempt, although the amount depends on how close you are to the bride or groom. The limits are up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else
- One less well-known type of unfettered gifting is to contribute to the living costs of someone else – younger or older relatives, for example – but only if you can prove it’s coming out of spare income
However, if you die before seven years have passed from the date of the loan, inheritance tax is levied on a sliding scale – starting at the full whack of 40 per cent if it’s within the first three years and will fall to your beneficiaries to settle.
Trusts: Gifts with strings attached
- With trusts, you are still giving money away and the seven year rule still applies, but you have more control than if you simply hand over your cash to someone else. This is often a sensible way of passing on money to children or grandchildren, if you think they are too young to spend it wisely
- A very simple ‘bare trust’ or ‘absolute trust’ allows trustees you have appointed to keep control until beneficiaries are 18 – which might still seem too young especially if large sums are involved. A ‘discretionary trust’ is more complicated but you can tailor the rules to suit the people involved and the circumstances
- You will need professional help from a financial planner or lawyer to set up a discretionary trust, and probably at intervals in the future too
Life insurance: Put the policy in trust
- Taking out life insurance can mean your loved ones get a payout straight after your death and free of inheritance tax – but you have to set it up correctly
- To stop a life policy payment getting rolled into your estate, and the taxman potentially grabbing 40 per cent of anything over your inheritance tax threshold, you need to put it into trust
- Placing in a trust allows you to appoint one or more beneficiaries of the trust, who will be paid the full sum due when you die, and without the delays involved with inheritance payouts
- You can insure your life for the sum you think your heirs will have to fork out in inheritance tax, to offset their liability
- Beware though that premiums can be high, especially as you get older, and if you cancel a policy you immediately lose all the benefits of taking it out in the first place
- You also need to be in good health, to avoid HMRC thinking you are just trying to dodge inheritance tax
- Putting a life policy into trust can be done with the help of a financial adviser, and you might well need legal input too
Home ownership: Switch from being ‘joint tenants’ to ‘tenants in common’
- Most people who own property together do so as joint tenants. That means they ‘jointly and severally’ own 100 per cent of the home, and when one dies the other becomes the 100 per cent owner. This overrides anything you may say in your will, so you cannot leave your share of the property to anyone else
- Spouses don’t pay inheritance tax so there is no liability at that stage if they get the home after the death of a first partner – although if the co-owner is anyone else it could be due, subject to the usual thresholds
- However, if a couple opts to make their ownership ‘tenants in common’, they have the option of splitting it differently – say, 40/60 – and leaving their share to someone other than their partner
- You may not want your partner to inherit your share of the property, because this could increase the value of their estate so that when they die their heirs have to pay inheritance tax. Before the second death, some value is already out of the estate. So if it was 50/50, and 50 per cent went to a son, it would now be out of inheritance tax. If you and your partner have children, you could leave your share of the property to your children so that when your partner dies only his/her share of the house is counted as part of his/her estate
Please remember that IHT planning is a complex area, so if in doubt you should always seek professional financial advice. Remember too that tax rules can and do change over time, so it’s important to regularly review your position and how current legislation affects you. Redwood are here to help you with the advice you need. Our Free Public Seminars provide you with an in-depth insight into growing, protecting and enjoying your wealth. Book online at: Book Me A Place!: call us on 01489877 547 or Email firstname.lastname@example.org.