How to Plan for Inheritance Tax

Everyone’s financial situation is unique, and the impact of inheritance tax will vary person to person. However, here’s a rough idea of how the tax is applied.

Inheritance tax is not dealt with directly by your beneficiaries, but by the executor of your will. The current rate is 40%, and this is only charged on estates that exceed a certain value. No tax is payable below £325,000 – this is known as the nil rate band, and it can be transferred to your partner if you die. If you leave your main residence to a direct descendant, your estate will benefit from a residence nil rate band which currently stands at £175,000. Simply put, a couple can leave a £1m estate to their direct descendants without it being liable for any IHT.

Value Estate.

Planning for inheritance tax requires you to know the value of your estate, so make sure to comprehensively work this out before you begin exploring the options available. You need to value every asset you own based on what it would earn if sold on the open market at the time of your death and add everything together. This will give you the gross value. To determine the actual worth of your estate, you’ll then need to subtract any debts like mortgages or unsecured loans.

Write Will.

Writing a will is a critical part of estate planning, enabling you to dictate exactly what should happen to your money, property, and possessions after death. If you don’t write a will, your estate will be subject to the rules of intestacy. Depending on how you want to pass on your estate, these rules may not provide the right outcome – so set your wishes in stone.

Utilise Exemptions & Allowances.

Every year, there are several exemptions and allowances you can make use of to limit the amount of IHT your estate will be charged. Doing so reduces the value of your estate, and the tax bill as a result. The options available include:

• Annual Exemption – you can give away £3,000 tax-free every year.
• Small Gifts Allowance – you can give away £250 per person every tax year as long as another allowance hasn’t already been used on that person.
• Birthday & Christmas Gifts – these can be made from your regular income.
• Wedding & Civil Partnership Gifts – depending on your relationship to the couple you can give away an amount of money tax-free for weddings and civil partnerships. Parents can give away £5,000, grandparents can give away £2,500, and anyone else can give away £1,000.
• Potentially Exempt Transfers – you can give more gifts than the above allowances as long as you outlive them by 7 years. If you don’t, your estate will be taxed on a sliding scale known as taper relief.

Preserve Pension.

Whilst assets like cash, savings, and property will all contribute to the total value of your estate, anything still in your pension pot may not. As a result, you can pass on most types of pensions without being charged IHT because they are established under a discretionary trust. If you have other forms of income to live on in later life such as rent, investments, or salary from a part-time job, preserving your pension could be a great way of passing on significant wealth tax-free.

Income in Retirement >

Set Up Trust.

Setting up a trust can be a popular way to avoid IHT, however the law in this area can be complex, so make sure you get professional advice. Whilst many people think trusts are exempt from inheritance tax, this isn’t strictly true. The way a trust is taxed will depend upon the type of trust you set up, and how much is put into it. The most common trusts used for IHT planning are discretionary trusts. Typically, an amount up to the nil rate band can be put into trust without being charged. After this, the trust will be charged at a reduced rate of 20%.

Get Life Insurance.

Some people choose to take out a life insurance policy as a form of tax planning. These are held in trust and pay out a tax-free lump sum upon your death, making it a great way to continue to provide for your loved ones. Often, this lump sum is released before probate is granted, providing vital financial relief during this difficult period. For more information on life insurance, check out our dedicated blog.

Give Away Excess.

If you have surplus income that you can give away without it impacting your quality of life, you may be able to do so tax-free. In order for these gifts to be exempt, however, the following conditions will need to be satisfied.

• The gift is part of typical expenditure.
• The gift is from your income after tax.
• After allowing for all other typical expenditures, you can maintain your usual standard of living.
• You keep good records of these gifts to report to HMRC.

Donate to Charity.

You can reduce the rate of IHT you pay through making a charitable donation upon your death. All donations to charity are exempt, but you probably don’t want to give your entire estate away. Instead, donate just 10% of its net worth. That way, your money will make a positive impact, and the IHT rate on the rest of your estate will reduce from 40% to 36%. If there’s a cause you’re passionate about, you could make your will a final good deed.

Choose IHT Efficient Funds.

You can also plan for IHT through your investment portfolio because certain funds qualify for Business Property Relief (BPR). You can get a 100% exemption through BPR on a business or interest in a business as well as shares in an unlisted company. You can get 50% BPR on shares controlling more than 50% of the voting rights in a listed company, as well as property or machinery owned or held in trust and used in a business you were a partner in or controlled.

Need advice? Contact us today about IHT efficient wealth management.

Spend It.

Knowing our loved ones will inherit our wealth is a comforting thought. However, there’s little point living your later years on a tight budget if a significant proportion of this will go to HMRC instead. That’s why perhaps the most fun way to plan for IHT is to spend money! Your retirement should be a time in your life when you do all the things you want to do and live the lifestyle you have spent your whole life working towards. Instead of fretting about finance, why not enjoy some well-earned luxury?

Plan a retirement that works for you >

Equity Release.

If a large proportion of your estate is composed of illiquid assets, you won’t be able to make use of your gift allowances. For those who know their property wealth will make them liable for inheritance tax, equity release can be a great way to convert it into liquid cash. This cash can then be used to max out on all the IHT allowances we discussed earlier in this article, or invested in an IHT efficient fund.

How Does Equity Release Work? >

Ask for Help.

As you might have gathered by now, inheritance tax is complicated! If you’re looking for ways to mitigate your tax responsibilities, getting expert advice is key. Our financial life planners can help you craft tax efficient plans that help you reach your life goals and preserve your wealth for loved ones to inherit.