Inheritance tax, sometimes referred to as IHT, is a tax placed upon money and property that is gifted or inherited. Understandably many people approaching older age want to protect their estate and loved ones from the impact of IHT. This is often known as Estate Planning.
In this article, we will:
Before we start, here is a short video explaining what inheritance tax is.
IHT was introduced by the government to replace a tax called capital transfer tax, which was essentially similar. This tax is applied to the funds in your estate – the house and assets you leave behind when you die.
In 2018 it was set at a rate of 40%, which is applied to your wealth over the current tax-free threshold of £325,000. This is also known as the ‘nil band rate’. You can read more about this and your allowances below.
The tax is paid to HMRC from funds out of your estate on your behalf by your executor – the person responsible for carrying out the instructions in your will.
Beneficiaries won’t normally pay tax to HMRC – although occasionally they may have to pay inheritance tax. This usually occurs if you give away more than £325,000 and die within seven years of doing so.
The amount of iht you’ll pay depends on your personal situation and the total value of your wealth.
The question ‘how much is inheritance tax’ is not straightforward to answer – as much of it depends on you – how much you have and how your assets are distributed.
There are several things that influence the amount of inheritance tax you’ll have to pay. These are known as ‘reliefs and exemptions’ set out by the government to help protect certain individuals from paying the tax.
– The £325,000 tax-free threshold: This was introduced to protect people with wealth amounting to less than £325,000 from the tax. For many, this eliminates the tax altogether – but it’s important to remember that this amount refers to the total value of your estate, not just your home.
– Leaving your entire estate to a spouse, partner or charity: If you leave your estate in full to a spouse, partner or to charity, you are exempt from paying inheritance tax.
– Giving away your home to children or grandchildren: If you give away your home to children or grandchildren, the tax-free threshold increases to £450,000. This also applies to step-children, adopted children and foster children.
– Transfer of unused threshold: If you are married or in a civil partnership and your personal estate amounts to less than the £325,000 threshold, the remainder of the unused threshold can be added to your partner’s threshold upon your death. This means that their threshold may be as much as £850,000.
If none of the above applies to you, or still leave you with assets at risk of being taxed, you may want to know how to remove inheritance tax altogether.
If you’d like to avoid inheritance tax or minimise the amount you’ll have to pay from your estate, there are a number of options available. These are simple and easy ways to organise your assets and potentially remove inheritance tax altogether.
It’s important to mention that these will only work if your financial situation is fairly straightforward. For more complex matters, proper planning and advice from a professional financial advisor is recommended – more on this below.
When you are married, or in a civil partnership, you can give anything you own to your civil partner or spouse. This means that your estate will not have to pay inheritance tax on what the gift is worth.
There are rules to bear in mind with this option – which can become complex if your spouse/civil partner was born outside of the UK or permanently lives outside of the UK. If this is the case, you should seek professional advice.
You can give money or assets as gifts to family members and friends who are not classed as your partner or spouse. It is only classed as a gift if you give it outright (so that you no longer have any benefit from it).
The value will still be included in your estate value for inheritance tax purposes – but only for seven years.
After this time, it is excluded from the total value and therefore, cannot be taxed. Bear in mind that you can only give away limited amounts per year – up to £3,000 annually.
Capital Gains Tax may be payable on certain assets – so it’s worth discussing gifts with your solicitor or financial advisor to be completely sure.
As mentioned above, if you leave all of your estate to charity, there will be no iht to pay. However, many people only wish to leave a portion of their estate to charitable causes and the rest to family members and friends.
There are still advantages to charitable donations upon death – if you leave 10% or more of your estate to a charity, the amount due on the rest will decrease considerably. This is because instead of being calculated at 40% the rate reduces to 36%.
Taking out life insurance and directing the money into a trust will not directly reduce the amount of inheritance tax you’ll have to pay – but it will make it easier for your surviving family members to pay the bill. The payout may prevent them from selling the family home, for example.
One issue that many people look at is how to avoid inheritance tax on their home. Whilst this is a complex subject, a trust can be one way to achieve this.
This is a legal arrangement that enables you to give cash, property or investments to somebody else to look after for the benefit of a third party.
You can, for example, put savings in trust for your children – or a spouse.
There are two important roles required within a trust fund.
The first is a trustee (the person that owns and manages the assets in the trust). The second is a beneficiary (the person that the trust is set up for. Often they are unable to manage it themselves due to age, disability, etc.).
When you put items in a trust they no longer belong to you – and this is where the inheritance tax benefit arises.
If you’ve read the options above and are still unsure about which to take, you may like to consider setting up a trust to avoid inheritance tax. There are many different types of trusts available – all with advantages and disadvantages depending on your situation.
Setting up a trust to avoid inheritance tax does have a range of implications both for you and for family members, so it’s advisable to discuss these at length with your solicitor or financial planner when considering the options available to you.
– Interest in Possession – An interest in possession trust is set up to entitle the beneficiary to any income as soon as it is produced. It also allows you to benefit from living in and enjoying your property whilst it is in trust.
Income mostly includes financial interest accrued, but could also cover you living in and enjoying your property for years to come. You can read more about it here.
– Protective property trusts – These are are a type of legal structure that can be included as part of your will. It is designed to protect your property from being included in assessments that are carried out to determine how much you should contribute to long-term care fees.
A Property Protection Trust Will covers a share of a jointly-owned property to ensure that surviving spouses or partners can continue to benefit from their deceased partner’s share in their home even when they are gone. You can read more about it here.
Here is a video that explains more about how property protection trusts work.
– Life Interest Trust – A life interest trust allows you to specify who owns the rights to your property – which can protect you and family members should you need care in the future. It’s also a good way to preserve your assets and protect against iht. You can read more about it here.
If you are a business owner, you can transfer interest in your business to a friend, relative or business partner without being subject to inheritance tax. This transfer can be made before or at the time of your death.
It is possible to transfer shares and other finances related to business to a business partner without having to pay any tax. You can then specify that certain assets are transferred to your loved ones at a suitable time after your death.
Under the terms of Agricultural Relief, it is possible to transfers certain types of buildings and agricultural land without being subject to inheritance tax.
It may be a good idea to seek legal representation to make sure that your assets are distributed in a fair manner and that there are as few conflicts as possible.
Take the time to work out how much you need to live on and consider giving everything else away to your close friends and relatives.
Gifts in the form of property or money that you present to a relative at the time of their wedding are not subject to tax.
If a child or another close relative is getting married, this is the perfect time to pass on their inheritance to them so that they will not be subject to tax.
It may be a good idea to put a provision in your will stating that they have already received their inheritance so that they do not make a claim for further monies after you have passed away.
If you are faced with a terminal illness, this is a good time to treat your friends and family members to a special holiday or another type of experience that you can share together.
Not only will there be less capital after you pass away for your loved ones to be taxed on, you will also have the chance to make some final memories that those close to you are likely to treasure for many years to come.
It’s your money so you can spend it! Why save your money knowing that a significant portion of it could be taken away through inheritance tax? Instead, why don’t you enjoy life and treat yourself to some nice holidays and gadgets that are going to make your life easier. A good example could be an electric recliner chair.
in 2015 the government announced that when parents or grandparents pass on the main residence to their children, step-children or grandchildren, and if it is worth up to £1 million (£500,000 for single people) then Inheritance Tax would be scrapped.
The threshold for inheritance tax is currently £325,000. This is also known as the nil rate band and can be transferred to a spouse or civil partner on death. Therefore, this gives you a total nil rate band of £325,000.
The basic allowance of £325,000 remains unchanged. What has changed is the introduction of the new ‘residence nil rate band’ (RNRB). This is also known as the ‘main residence’ band.
This is an additional allowance you’ll receive on top of your existing allowances if you pass on your main residence. It was introduced as part the 2017/18 tax year and is being phased in gradually, reaching a £1m exemption for couples in the 2020/21 tax year.
The 2019/20 tax year has seen the residence nil rate band (RNRB) allowance go up to £150,000 (meaning a total individual allowance of £475,000 when you add it to the £325,000 allowance) and it will rise again by £25,000 in 2020/21 when it reaches £175,000 (meaning a total allowance of £500,000).
You are able to make small gifts of up to £250 per year to anyone you like.
There is no limit to the number of recipients in one tax year, and these small gifts will also be free from inheritance tax, provided you have made no other gifts to that person during the tax year
It’s worth noting that there can sometimes be consequences associated with avoiding inheritance tax. Primarily it often makes your financial situation more complicated. Other issues associated with avoiding inheritance tax include:
If you have had a will drawn up previously and then decide to redistribute and rearrange your assets, it will need to be updated to reflect this. Remember that this will incur an additional cost or fee from your solicitor. You can read more about making a will here.
If you choose to give away money outright as gifts or tie it up in trust funds, you may find that you don’t have enough income to enjoy life or spend on essentials such as care costs.
Don’t forget that other types of tax may be applicable on certain assets and gifts, such as Capital Gains Tax. You may find that by avoiding inheritance tax, you may end up unexpectedly paying more with other taxes.
If you’re going into residential care or will need some sort of care provision imminently, it may be too late to rearrange your assets and finances.
Any gifts made may be seen as deprivation of assets and will be means-tested anyway – which reduces the amount your local authority is willing to pay towards your care. You can read more about avoiding care fees here.
Avoiding inheritance tax must be legal and above board. If you try to hide assets or dispose of them in a different way you may find you’ll still be liable to pay. This can make things complicated for your loved ones when you pass away.
By far, the MOST important thing to do when looking to set up a trust is to ensure you use a specialist. This will ensure that it is legally compliant and that it is set up for the correct purposes.
Even the smallest mistake can make it invalid, which would, therefore, make the exercise you undertook worthless.
To find out which type of trust is best suited to your needs, you’ll need professional advice and support from a solicitor or financial advisor.
If you want to understand how to avoid inheritance tax, one key factor is early preparation and planning. The earlier you start to think about how you will manage and divide your estate the better.
Ability to leave as much as possible to family and friends when you’re gone
This is the main reason people start to plan early, as they want to make sure their loved ones are provided for.
Inheritance tax planning with plenty of time to spare ensures that this can happen.
Your financial advisor will also get in touch should the rules change at any time – so you can keep on top of them and adjust your plan accordingly.
If you would like to know how to avoid inheritance tax and have a complex or unusual financial situation, or a large estate, we strongly recommend speaking to a professional financial advisor.
They will be well-versed in later life financial planning and can offer tailored advice specifically suited to your needs. They can even work with a solicitor to set up trust fund structures and put other measures in place to help you to avoid inheritance tax.
Leave your details below if you would like some help in setting up a Trust.