Ensuring your inheritance
Rising property prices mean increasing numbers of people will now leave their families with a tax bill of hundreds of thousands when they die, yet with a bit of planning it’s possible to significantly mitigate most or all inheritance tax. Many people ignore inheritance tax planning, as they don’t want to consider the future or think they have plenty of time remaining to sort things out, but it’s extremely important if you want to pass on any of your wealth.
What is inheritance tax?
Inheritance tax is paid on the assets you leave after you die, after inheritance tax allowances are deducted. Your assets include cash, property, investments, vehicles and possessions. After you die, the Government will assess how much your estate is worth, then deduct any remaining debts from this to give the value of your estate.
The aim of inheritance tax is to redistribute wealth, so some of your money goes to the state to be distributed for the benefit of all, rather than simply being passed on to your heirs. However, the steep increase in house prices has left many families unexpectedly caught with an estate that is over the inheritance tax threshold.
The current inheritance tax threshold is £325,000, and anything above that will be taxed at a rate of 40%. But there are various ways in which you can bring down the amount of tax on your estate.
Passing on a home
The Government has also introduced a new ‘residence nil rate’ band, allowing parents or grandparents to pass on a home worth up to £1 million (or £500,000 for singles). This is being phased in gradually until April 2020. If you pass on your home to your wife, husband or civil partner when you die, they won’t have to pay inheritance tax on its value. If you leave it to your children (including adopted, foster or stepchildren) or grandchildren, your tax-free threshold will increase to £425,000. If you leave your home to anyone else, it will count towards the value of your estate as normal.
You could choose to give away your home before you die, which means, as long as you move out and live for another 7 years, there will be no inheritance tax to pay on its value. If you’d like to continue to live in your property, you’d need to pay rent to the new owner at the going rate, pay the bills and live there for at least 7 years. However, if the new owners move into the home with you, or you only give away part of your property, you won’t need to pay rent.
For more information on the residence nil rate band, download our guide.
What if I’m married?
When you die, any assets you leave to your spouse or civil partner are exempt from inheritance tax, provided they live in the UK. In addition, any part of your inheritance tax threshold that was not used can be added to your partner’s threshold, meaning a couple can together leave up to £850,000 tax-free.
So for example:
John and Janet Smith have combined assets worth £950,000 between them. John dies and leaves £280,000 to their children, leaving 12.3% (or £45,000) of his allowance unused. This remaining percentage will pass on to Janet, allowing her to leave 1123% of her allowance to her children tax-free, plus a further £85,000 on the residential nil rate bank Any assets over that threshold will be taxed at 40%.
You do not need to do anything to set this up, but the executors of your estate will have to claim the unused threshold from the HMRC when you die.
If you’re not married or in a civil partnership, the situation is much more complicated.
Giving away income
You can give away £3,000 each tax year during your lifetime without paying any inheritance tax on the gift. This allowance can only be carried forward one tax year. Small gifts, eg birthday presents for your grandchildren, of up to £250 to any one recipient per tax year are excluded from inheritance tax and do not count as part of your annual £3k gift exemption.
You can also give away any surplus income you have without limit for an immediate deduction – however HMRC rules on what is ‘surplus’ are complex.
You can gift larger amounts to your heirs without paying inheritance tax, as long as you live for a further seven years. If you plan to do this, it’s obviously better to do it earlier rather than later, but your beneficiaries could take out life insurance against a potential tax bill if it’s a large amount.
Most gifts made into a trust are now subject to inheritance tax, even if they are made during your lifetime. To minimise tax in this area it’s best to get specialist advice.
Gifts to charities and political parties are tax-free, and you should get an income tax deduction in your lifetime. If you leave at least 10% of the net value of your estate to charity on your death, you’ll only pay a reduced inheritance tax rate of 36% on the remainder.
These rules only apply if the amounts paid are genuine, unconditional gifts that you make with no intention of receiving something in return.
Should I get professional advice?
Inheritance tax planning is extremely important; there is no point spending a lot of time and effort building and protecting your wealth, only to have most of it go to the HMRC on your death. The first step is always for you (and your partner if applicable) to make a will.
Beyond that, if your total joint assets come to under £650,000 your estate shouldn’t be subject to inheritance tax. For those with larger estates, an independent financial adviser such as John Lamb will be able to put together a plan tailored exactly for the assets you own and the way you’d like to leave them, while taking full advantage of all possible tax reliefs.
For more information, download our guide on the "Residence Nil Rate Band" Rules.
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