As with most good plans, it will pay to start thinking about inheritance tax early. The rules can be complex and change regularly, so you will need to review your circumstances often.

It may be wise to speak to a financial adviser about how best to approach inheritance tax. With the right planning, your bill could be reduced or even mitigated completely, meaning your loved ones can enjoy the most of their inheritance.

What is inheritance tax?

Inheritance tax (IHT) is calculated and payable on your estate upon death. Your estate includes everything you have of value, such as your home, jewellery, savings and investments, cars and even works of art.

How is inheritance tax calculated?

Inheritance tax will usually be payable if your estate exceeds the nil-rate threshold, which will be fixed at £325,000 until 2021. Below this, your estate can be passed to your beneficiaries free of tax. If you own your home and plan to pass it on to your blood relatives when you die, then all or part of this may fall outside of your estate when calculating inheritance tax.

It's also the case that anything left to either your spouse or civil partner will be exempt from inheritance tax, regardless of whether the value exceeds your nil-rate threshold. The same applies to exempt beneficiaries, such as charities. 

The value of your estate that is above the nil-rate threshold of £325,000 will be taxed at 40%. For example, if your estate comes to a total of £400,000, the nil-rate threshold will shield the first £325,000 from inheritance tax, but the remaining £75,000 will be taxed at 40%.

By leaving 10% or more of your estate to charity, it will usually qualify for a reduced rate and as such, the amount of inheritance tax due will be 36%.

Note: Rates and thresholds are based on current UK legislation and are subject to change.

What is the residence nil-rate threshold, and how is it different to the nil-rate threshold?

If you are giving away your home to your children (including adopted, foster and stepchildren) or grandchildren, you may qualify for the residence nil-rate threshold before inheritance tax becomes due. This will be an additional;

  • £100,000 in 2017 to 2018
  • £125,000 in 2018 to 2019
  • £150,000 in 2019 to 2020
  • £175,000 in 2020 to 2021

It will then increase in line with the Consumer Prices Index (CPI) from 2021 to 2022 onwards. The residence nil-rate threshold will only apply up to the value of your property.

If you qualify, your inheritance tax threshold for 2017 to 2018 will be £425,000 (£325,000 + £100,000). The additional threshold will also be available if you have downsized or ceased to own a home on or after 8 July 2015, if the former home would have qualified for the additional threshold. There will be a tapered withdrawal of this threshold for estates with a net value of more than £2 million, this will be at a rate of £1 for every £2 over the threshold.

Note: Rates and thresholds are based on current UK legislation and are subject to change.

Using a spouse’s unused nil-rate threshold

If you are married or in a civil partnership and your partner’s estate is worth less than his or her nil-rate threshold, anything that is unused can be added to your threshold, providing your executors make the necessary elections within two years of your death.

There are also transferability options for spouses and civil partners who don’t use the additional threshold on first death. A number of conditions will apply, so you should speak to a financial adviser at AFH to discuss your options.

Note: Rates and thresholds are based on current UK legislation and are subject to change.

How is inheritance tax paid? 

Your executors or legal personal representatives must calculate the value of your estate, submitting full details to HM Revenue & Customs (HMRC). Typically, they will then have six months from the end of the month of death to pay any inheritance tax due. Access to the estate can’t be granted to the beneficiaries until this has been done, meaning the release of your estate could be delayed if your loved ones don’t have the funds to pay the inheritance tax bill.

If inheritance tax has to be paid with regards to land, business assets or property, it's possible to do so in instalments. In certain circumstances, your beneficiaries will then have up to 10 years to pay the tax owed, plus interest.


Why is it important to plan ahead for inheritance tax?

While the nil-rate threshold of £325,000 may seem like a lot, your estate includes all of your possessions, such as your home, jewellery, cars, antiques and savings. In order for your loved ones to benefit fully from your assets, it’s important to consider the impact that inheritance tax could have on your estate, and how you can protect against it.

The rules and exemptions around inheritance tax can change regularly, meaning so will the opportunities available to you. Although many people view the inheritance tax as unfair, with the right planning, it can often be reduced or mitigated completely.

How can I limit my inheritance tax liability? 

It should be pointed out that inheritance tax is an extremely complicated area and there can be severe penalties for breaking tax rules.

You should speak to a financial specialist before taking any action. Our experienced independent financial advisers can create an inheritance tax plan that is tailored to your specific circumstances. There are many ways in which a financial adviser will be able to ensure that your loved ones receive the most of their inheritance.

Ways to limit your inheritance tax:

Writing a will

If you die without leaving a will, your estate will be shared out according to the rules of intestacy. This means the law will decide how your assets are distributed. Only married or civil partners and some other close relatives can inherit under the rules of intestacy.

Should this happen, your estate may not be distributed how you would have preferred, and you are likely to have to pay significantly more tax than if you had left a valid will. By putting a will in place – and keeping it updated – you can ensure that when you die, your estate is shared out according to your wishes, and as tax-efficiently as possible.

Some of this advice is not regulated by the Financial Conduct Authority.

Gifts

When it comes to calculating the amount of inheritance tax you owe, the value of your estate will include anything you have given away to a friend or family member, who is not your spouse or civil partner, up to seven years before your death.

Generally, if you continue to live more than seven years after you’ve made the gift, it becomes fully exempt from inheritance tax. Gift exemptions include;

Annual exemption

Individuals are entitled to give away £3,000 in total, each tax year, free from inheritance tax. This allowance can be backdated by one year, so where the full £3,000 is not used, it can be carried forward to the next tax year.

This means a married couple could give away a total of £6,000 a year to their children without incurring inheritance tax (or £12,000 if the previous year's allowances were unused).

Small gift exemption 

Outright gifts of up to £250 in total, to each of any number of people in one tax year, are exempt from inheritance tax. The total of any one person’s allowance can’t form part of any larger gift.

Normal expenditure from income

Lifetime gifts are made by you while you are alive. To benefit from this exemption the gifts need to be made regularly (e.g. yearly) and out of true income (e.g. dividends and interest from investments). Provided they do not affect your usual standard of living, they should be exempt from inheritance tax.

There is no maximum limit on the amount which can qualify for this exemption, however this amount is only confirmed (or not) as exempt on death and therefore some gifts may still be classed as being within your estate for inheritance tax purposes. Your financial adviser will be able to explain this to you further.

Marriage and civil partnership gifts

You are able to give up to £5,000 as a tax-free gift if your child is getting married or registering a civil partnership. You can give £2,500 to a grandchild or great grandchild, and £1,000 to anyone else. This applies per person, meaning parents could give up to £10,000 to their child.

Other exemptions 

Maintenance gifts can be given for the upbringing of children (under 18s) and others who are dependant due to old age or illness. Also exempt are gifts and bequests;

  • to charities
  • to political parties
  • to universities
  • for national purpose
  • for public benefit.

Gifts with reservation (GWR) & pre-owned asset tax (POAT)

A gift will only become exempt from inheritance tax providing you ceased to receive benefits from the asset when you gave it away, otherwise it will be known as a gift with reservation (GWR). For example, if you transfer to someone the interest of your property, but remain living in it until the time of your death, you are continuing to receive a benefit from the asset, meaning it will still form part of your estate when you die, regardless of when you gifted it.

In order to counter a number of arrangements that sought to avoid the reservation of benefit rules, pre-owned asset tax (POAT) was introduced. Consequently, where you have given a gift to someone and continue to benefit from it, but you conclude that a reservation of benefit doesn’t arise, you may still face a pre-owned asset charge instead. This is a complex area, and it is recommended that you seek detailed guidance from an independent financial adviser.

Investing in BPR-qualifying companies

Business property relief (BPR) can alleviate inheritance tax on the transfer of relevant business assets at a rate of 50% or 100%. In order to qualify, a company must not be trading on a main stock exchange. Once BPR-qualifying shares have been owned for at least two years, they can be passed on free from inheritance tax upon the death of the shareholder.

Investing in the shares of BPR-qualifying companies can be beneficial if you don’t want to give away large sums of money in your lifetime, or if you want to give the inheritance you plan to leave behind the chance to grow.

However, you should keep in mind that tax rules could change over time. There can’t be any guarantee that companies that qualify today will remain BPR qualifying in the future, and the value of tax reliefs will depend on an investor’s personal circumstances.

Setting up a trust

Trusts can be a useful way of reducing the impact of inheritance tax. Assets such as cash, property and investments can be placed in trust. The trust will dictate who the beneficiaries can be and as long as you are excluded, you will be viewed as having gifted the assets into the trust.

You can appoint trustees who will manage the trust on a day-to-day basis, while maintaining control over trust investments and who will benefit from the trust (known as the beneficiaries). Trustees can provide a very effective way of controlling and protecting family assets, particularly if someone is unable to handle their own affairs.

A trust can be set up right away, or you can establish one in your will. There may be capital gains tax consequences if you transfer certain assets into a trust in your lifetime, but there will be no liability to capital gains tax if you establish a trust in your will.

Bear in mind that some types of trusts are subject to their own tax regimes and may be liable to inheritance tax. The rules around trusts are complicated so it is recommended that you speak to a financial adviser before proceeding.

Life insurance

A life insurance policy can be used to provide the funds to pay some or all of an inheritance tax bill, alleviating the stress from your loved ones. This can help prevent assets being sold in order to cover the costs of inheritance tax.

Ensure the policy is written into a trust. Otherwise, the money from the insurance pay-out is counted as part of your estate and subject to inheritance tax. An independent financial adviser will be able to search the whole of the market to find the best life insurance policy that suits your specific needs. You can find out more about life insurance policies here.

What will happen to my pension if I die? Will this affect my IHT liability?

In most cases, many pension plans are written under a trust, meaning your funds should be kept outside of your estate and can therefore be passed onto your loved ones free of inheritance tax. Although the majority of pension plans will be written in trust by default, some older plans may not be – you should check with your provider if you are unsure. 

You should keep in mind that if you make a pension contribution, or reduce the income you are drawing from your drawdown plan while in ill health, or within two years of death, the funds could still be liable to inheritance tax. If you wish to learn more about pensions, please visit our pensions overview.

Inheritance can be an extremely complex area, but planning for it in advance will help your loved ones to get the very most out of their inheritance. If you are unsure about where to begin, contact AFH and speak to an independent financial adviser.

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