Inheritance tax (IHT) can cost loved ones a significant sum in the event of your death without careful planning in advance. It can seem a complex subject to understand with numerous rules but it’s important to get financial advice as early as possible to benefit from the tax reliefs and exemptions available to you.
At Trinity Finance, we can help you navigate this matter to successfully manage your inheritance tax liability and maximise the amount you leave to your loved ones via your estate. In this guide, we’ll explain what inheritance tax is, how it’s calculated, how IHT planning can help and ways to reduce your IHT liability.
What is inheritance tax?
Inheritance tax is a charge that’s levied after your death, which is based on the value of your estate. Your estate includes all of your possessions and assets, such as your property, car, cash, pension fund, investments, personal items, insurance funds and digital assets. If you’re domiciled in the UK – meaning the UK is where your permanent home is – the IHT payable is also based on your foreign assets. If you live abroad but have assets in the UK, you may also be subject to IHT. Any inheritance tax that’s due must be paid before your estate can be passed to your beneficiaries as specified in your will.
The IHT bill is paid by the executor of your will or by the administrator of your estate if you haven’t written a will. The funds to pay the bill are usually taken from the estate. In some cases, it may be necessary to sell some of the estate’s assets to make this payment. The payment needs to be made to HM Revenue and Customs (HMRC) within 6 months of your death otherwise interest will be charged on this amount. Once the IHT bill has been paid, probate will be granted. Your beneficiaries can then receive the inheritance you’ve passed to them.
How is inheritance tax calculated?
The current tax-free threshold – called the nil-rate band – is £325,000. This personal tax allowance means that if your estate is valued at £325,000 or under, no IHT will be payable. For an estate that’s valued over this amount, the first £325,000 can be passed to your beneficiaries tax-free. Anything above £325,000, however, will be subject to IHT at a rate of 40%. If your estate is worth £500,000, for example, no IHT will be payable for the first £325,000 but 40% will be charged on the remaining £175,000. This rate can be decreased to 36% if you leave at least 10% of your estate to a charity named in your will. Any unused allowance from your estate can be transferred to your spouse or civil partner. As they also have a personal tax allowance of £325,000, this effectively doubles their tax-free allowance to £650,000 if all of your allowance is unused.
How does inheritance tax planning help?
The increase in house prices over recent years means that it’s no longer just those with large estates who need to think about the impact of inheritance tax. When you calculate the value of all your assets and possessions, you may be surprised at just how much your estate is worth. This means it’s likely that IHT will be payable, reducing the amount you can leave to your beneficiaries. As inheritance tax isn’t payable until after you’ve died, you may not have given it much thought. However, it’s worth getting inheritance tax planning advice sooner rather than later. There are ways to reduce your IHT liability and some of the tax rules relating to this have time limits.
Our mortgage and protection consultants, located throughout Kent, London and Edinburgh, can provide you with expert inheritance tax planning advice that helps you to manage your estate effectively. They can discuss the various tax reliefs and exemptions that are available and ascertain which options you can take advantage of to reduce your IHT liability. This helps to maximise what you leave to your beneficiaries. Simply call us on 01322 907 000 to speak with one of our financial advisers. If you prefer, send us an email at firstname.lastname@example.org and we’ll provide you with more information. Alternatively, send an enquiry via our contact form and one of our specialist consultants will reply to you as quickly as possible.
Ways to mitigate your inheritance tax liability
When leaving your estate to your spouse or civil partner, no IHT will be payable regardless of the estate’s value. Also, as your nil-rate band of £325,000 won’t have been used due to this exemption rule, it will pass to them so their inheritance tax allowance becomes £650,000. Whilst this is the easiest way to mitigate your IHT liability, there are other ways to reduce the size of the tax charge levied on your estate.
Take advantage of the residence nil-rate band
This is an additional tax-free threshold that applies if you leave your main residence to your children or grandchildren. The residence nil-rate band is currently £175,000. This increases your tax-free allowance to £500,000 when added to the current nil-rate band of £325,000. Under this tax rule, stepchildren, adopted children, foster children, those under your guardianship and great-grandchildren are also included. This allowance only applies to estates with a value of up to £2 million. If your estate’s value exceeds this amount, £1 is reduced from the allowance for every £2 that’s over the £2 million value.
As with your unused nil-rate band, if you’re married or in a civil partnership and have an unused residence nil-rate allowance, it can be added to the tax-free threshold of your partner. This means they can have a threshold of £1 million, significantly reducing any inheritance tax that may be payable.
Give gifts to your family or friends
You can give a financial gift of up to £3,000 each tax year, known as your annual exemption, to your family and friends. You can divide this allowance between as many recipients as you choose as long as the total doesn’t exceed £3,000. Any unused allowance can carry over to the following year so, if you don’t gift any of your £3,000 tax-free allowance one year, you can gift up to £6,000 the following year. Not only does gifting money in this way allow you to see your loved ones benefitting from your money while you’re still alive but it reduces the value of your estate and, therefore, reduces the amount of IHT that may be payable.
You can also give away gifts of up to £250 to any number of individuals per tax year. This is known as your small gift allowance. These gifts are not included within the £3,000 annual exemption mentioned above but they are also exempt from inheritance tax. It’s important to note that you can’t use different allowances to benefit the same recipient.
Another example of an exempt transfer is a wedding gift. You can gift up to £5,000 per tax year towards your child’s wedding, £2,500 towards your grandchild’s wedding and £1,000 to someone else as a wedding gift. A wedding gift can be combined with an annual exemption gift. This means you can use your annual exemption to give your child £3,000 as well as a £5,000 wedding gift in the same tax year.
You should be aware that some gifts are considered to be potentially exempt rather than immediately tax-free. Potentially exempt transfers (PETs) are gifts that exceed the ones mentioned above. If the value of a PET falls outside of your nil-rate band allowance and you die within 7 years of giving the gift, IHT will become payable on it. If the gift is given within the last 3 years of your life, IHT will be charged at 40%. If it’s made between 3 and 7 years before your death, a taper relief scale will be used to determine the tax payable.
Make regular gifts from your excess income
You can make regular tax-free gifts from your income, such as your earnings or pension, as long as these amounts are in excess of what you need to live on normally. There is no limit to what you can give away. These regular payments help to prevent your estate’s value from increasing. As long as these payments don’t affect your lifestyle, they’ll be exempt from IHT. Known as normal expenditure out of income, these regular payments can be used to give financial support to a loved one. For example, you can ensure an elderly relative has extra funds to live on each month. Or you can pay the premiums for a pension plan you’ve arranged for your child.
Leave a gift to a charity
You may have a favourite charity that you wish to donate to during your lifetime or leave a gift to in your will. Any gifts given to charities as well as sports clubs, universities, museums and political parties are tax-free. As mentioned earlier, if you gift 10% of your estate to a charity in your will, the IHT rate will be reduced from 40% to 36%.
Set up a trust
You may wish to have some control over a particular asset. If this is the case, you can set up a trust to look after it on behalf of the beneficiary. Your appointed trustees will be responsible for looking after the trust. They will also administer the asset to your beneficiary according to your wishes. For example, you may want to lock a sum of money away to pay for your child’s deposit for their first home or to cover their university fees. Once the investment has been made into the trust, it no longer forms part of your estate. This reduces the value that can be taxed upon your death.
Have a life insurance policy
A good way to prepare for the IHT bill is to take out a life insurance policy that covers it. You need to ensure it is paid into a trust so that it falls outside of your estate and won’t be subject to tax. This will also allow the funds to be accessed as soon as they’re needed to settle the IHT bill rather than having to wait for probate to be granted.
Benefit from business property relief
If you own a business or have business assets, this forms part of your estate. You can benefit from business property relief (BPR) to considerably reduce the taxable value of these assets. Depending on the nature and usage of the assets, the reduction in value can be either 50% or 100%. You can give away some of your business assets while you’re still alive to benefit from BPR. Alternatively, you can include them in your will. If your assets are in the agricultural sector, you can take advantage of agricultural property relief (APR) as well as BPR in some instances. Business property relief can be a complex matter and our protection consultants can check whether you qualify for this form of tax relief. They can provide essential inheritance tax planning advice to ensure that no unnecessary tax is paid for your business or share of a business.
Leave your pension intact
If you have sufficient funds or assets to ensure you can enjoy living comfortably during your retirement, leaving your pension intact is a good way to reduce your IHT liability. By spending more of the funds you already have instead of using your pension pot, you gradually reduce the size of your estate and, therefore, the amount that can be taxed. As well as that, your pension isn’t included as part of your taxable estate so you can leave it to your beneficiaries tax-free.
We can provide you with expert inheritance tax planning advice
As you can see, there are numerous tax reliefs and exemptions to benefit from with careful planning in advance. At Trinity Finance, our mortgage and protection consultants – located throughout Kent, London and Edinburgh – can provide you with expert financial advice to help effectively manage the impact of inheritance tax on your estate. To discuss the options available to you and discover the potential savings you could make on IHT, give us a call on 01322 907 000.
Tax rules are complex and they continually change so it’s important to keep your IHT plan up to date. If you’ve already taken steps to mitigate your IHT liability, it’s worth getting in touch with one of our financial advisers to check that you’re still on the right track to minimising the IHT bill while optimising the assets you’ll leave to your beneficiaries. Our specialist consultants can also help you with other aspects of estate planning, such as making a will and creating a lasting power of attorney. For more information, give us a call on the number above or send an email to us at email@example.com. If you prefer, send us an enquiry via our contact form.