Inheritance tax (IHT) becomes payable upon your death and is based on the value of your estate. This can potentially leave a hefty bill to be paid, which can significantly reduce the amount you leave to your loved ones. With careful planning in advance, however, there are various ways to manage your inheritance tax liability to maximise your beneficiaries’ inheritance.
What is inheritance tax?
Levied after your death, this charge is calculated on the value of your estate, which includes all of your assets and possessions. If you’re UK domiciled, meaning your permanent home is in the UK, the IHT will also be calculated on any foreign assets you have. If you live abroad and have assets in the UK, IHT may become payable.
The IHT bill must be paid within 6 months of your death and is either paid by the executor of your will or your estate’s administrator if you haven’t made a will. If the bill isn’t paid within this time frame, interest will be charged on the amount due. Probate will be granted once the bill has been paid and your estate will then be passed to your beneficiaries.
How is it calculated?
Currently, you can benefit from a tax-free threshold of £325,000, which is called the nil-rate band. This means that if your estate is valued at £325,000 or less, you won’t be liable for any IHT. If your estate has a higher value, the first £325,000 will be tax-free when passed to your beneficiaries but anything over this amount will subject to an IHT rate of 40%. For example, if your estate is worth £500,000, no IHT will be charged on the first £325,000 but 40% will become payable on the additional £175,000.
Any unused personal tax allowance can be transferred to your spouse or civil partner. This means that, along with their own tax-free allowance of £325,000, their threshold will be doubled to £650,000 if none of your allowance is used.
Take advantage of inheritance tax planning
These figures may seem high and you may think that IHT is unlikely to have any impact on you. However, the increase in house prices alone in recent years has pushed many people’s estates over the tax-free threshold. When you work out how much your possessions and assets are worth, the value of your estate may surprise you. Consequently, IHT will more than likely be payable on your estate and this will reduce the amount you can leave to your loved ones. There are various ways to reduce your IHT liability, though, and some of the tax rules have time limits relating to this. It’s important, therefore, to get inheritance tax planning advice as soon as possible to take advantage of these tax rules.
Mitigate your inheritance tax liability
Our mortgage and protection consultants, located in Kent, London and Edinburgh, can guide you through the various options available to manage your IHT liability. Inheritance tax planning can seem a complex subject but our specialist consultants can help you navigate it to minimise the IHT bill and maximise what’s given to your beneficiaries. We’ve detailed some of the main tax reliefs and exemptions below for you.
Leave everything to your partner
If you’re married or in a civil partnership, no IHT will be payable if you leave everything to your partner, regardless of the value of your estate. This exemption rule means your nil-rate band of £325,000 will remain unused so, as mentioned earlier, it will pass to your partner and increase their IHT allowance to £650,000.
Capitalise on the residence nil-rate band
If you leave your main residence to your children or grandchildren, you can take advantage of an additional tax-free allowance of £175,000. Called the residence nil-rate band, the tax rule for this also allows you to leave your property in Bexleyheath to your stepchildren, adopted children, foster children, children under your guardianship and great-grandchildren.
If you’re married or in a civil partnership, any unused residence nil-rate band can be passed to your partner. Along with your unused nil-rate band, this means they can have a total tax-free threshold of £1 million. This significantly reduces any IHT that may be payable upon their death.
Share your wealth early and see your loved ones benefit from your money while you’re still alive. Your annual exemption allows you to give a gift of up to £3,000 every tax year to your family and friends, divided between as many recipients as you wish. You can carry any unused allowance over to the next year. By gifting money in this way, you gradually reduce the value of your estate and this, in turn, reduces how much IHT may eventually become payable.
As well as your £3,000 annual exemption, you can give as many gifts of up to £250 as you wish each tax year. This is called your small gift allowance and these gifts are exempt from IHT. You cannot give this gift to an individual who’s already benefitted from your annual exemption gift.
Another exempt gift is a wedding gift. For your child’s wedding, you can gift up to £5,000 per tax year while you can gift up to £2,500 for your grandchild’s wedding. You can also gift £1,000 per tax year to someone else as their wedding gift. This can be combined with your annual exemption gift so, for example, your child could benefit from a wedding gift of £5,000 plus £3,000 in the same tax year.
Other gifts include potentially exempt transfers (PETs). Rather than being immediately tax-free, these gifts are potentially exempt. If you die within 7 years of giving a PET and its value falls outside of your nil-rate band allowance, IHT will be charged on it. For a gift given within the last 3 years of your life, this charge will be made at 40%. For a gift made between 3 and 7 years before you die, the IHT payable will be determined by a taper relief scale.
Donate to a charity
Whilst you can donate to a charity in your lifetime, you can also leave a tax-free gift to one in your will. If you choose to gift 10% of your estate to a charity, the rate charged for IHT will be a reduced amount of 36% compared with the usual 40%.
Take out a life insurance policy
One way to cover the eventual IHT bill is to take out a life insurance policy. This needs to be paid into a trust so that it falls outside of your estate and won’t be affected by tax.
Set up a trust
A trust can be used to look after an asset on behalf of a beneficiary. For example, you may want to set aside some funds to cover your child’s university fees. Once these funds have been transferred into a trust, they no longer form part of your estate, which is a good way to reduce its taxable value. An appointed trustee will look after the trust and administer the asset in line with your wishes.
Use your excess income to make regular gifts
Another way to keep your estate’s value from rising is to give excess income away in the form of regular tax-free gifts. Called normal expenditure out of income, the funds used must be surplus to those you need to live on and can be used to financially support a loved one. For example, the regular payments can cover your child’s pension premiums or provide extra funds for an elderly relative to live on.
Leave your pension intact
If you’re able to live comfortably using savings or other assets without accessing your pension pot, this is an effective way to reduce your potential IHT bill. Living on these funds gradually reduces your estate’s value and, in turn, the taxable amount. Your pension doesn’t form part of your taxable estate so your beneficiaries can inherit it tax-free.
Use inheritance tax planning advice to your advantage
There are many other ways to mitigate your IHT liability, such as benefitting from business property relief (BPR) if you own a business or business assets. At Trinity Finance, our mortgage and protection consultants can discuss these tax reliefs and exemptions with you, providing expert inheritance tax planning advice so that you can adequately manage your estate and reduce the impact of IHT.
Just give us a call on 01322 907 000 or send us an email at email@example.com and our estate planning specialists – located throughout Kent, London and Edinburgh – can help you make a tailored IHT plan.