Inheritance Tax
Inheritance Tax
What to consider when inheritance tax planning?
WHAT IS INHERITANCE TAX AND WHY SHOULD I PLAN FOR IT?
Inheritance Tax (IHT) is a tax imposed on the estate of someone who has passed away. The deceased’s ‘estate’ is the value of everything that person leaves behind, including cash, investments, belongings, and property.
Some people don’t realise that a large proportion of your wealth, including property and even family heirlooms, may need to be sold to cover the tax bill when you pass.
Planning for inheritance tax means you can take steps now to lessen the bill imposed when you’re gone. This will leave less stress, and more assets for your beneficiaries rather than the government.
WHO PAYS IT AND WHEN?
WHO?
If you do not have a will in place (or it is invalid), the administrator of your estate will pay the tax charge, after getting the correct letters of administration.
If you have a valid will in place, the tax is paid on your behalf by the executor named in your will. The executor will need to value your assets, then tell HMRC the estimated value of your estate. The executor will usually need to apply for probate before they can pay inheritance tax and generally your assets cannot be distributed to your beneficiaries until IHT is paid.
It is a good idea to have a will in place. See our article about Estate Planning here to learn why.
WHEN?
The inheritance tax bill needs to be paid within six months of your death. After this time interest will start accruing unless some of your estate value is caught up in business or property. In these instances, there is an option to pay annual instalments for up to 10 years, however interest is still charged until the final payment is made.
HOW IS INHERITANCE TAX CALCULATED?
The amount of tax to pay is calculated on the value of the deceased’s estate. Essentially, the estate is calculated by adding up the value of all your assets (property, jewellery, cars, cash, investments etc), minus any debts.
IHT is then charged at 40% on the amount over the nil-rate band and residence nil-rate band (if applicable).
This is the basic steps and may be more complicated depending on your circumstances.
Gifts made within the last seven years of your life could be counted as part of your estate.
NIL-RATE BAND AKA INHERITANCE TAX THRESHOLD
The nil-rate band is £325,000 for the 2020/21 tax year. This means if the value of your estate is under £325,000, it will not be subject to inheritance tax.
Married couples or civil partners who leave their assets to the surviving partner do not pay IHT and they will inherit the deceased’s tax-free allowance (so long as they’re living in the UK). This will allow them two nil-rate allowances, meaning up to £650,000 can be left to their beneficiaries, IHT free.
RESIDENCE NIL-RATE BAND
Recognising the family home usually makes up a large percentage of an estate, the government introduced an additional ‘residence nil-rate band’ of £175,000 (for the 2020/21 tax year) which is added to the nil-rate band when property is left to a ‘direct descendant’.
A ‘direct descendant’ is a child of the deceased (including step-children, adopted or foster children) and their lineal descendants (their children’s children and grandchildren), and the civil partners/spouses of direct descendants (their widow or surviving civil partner).
As with the nil-rate band, if you pass and leave your property to your spouse, they do not pay inheritance tax, and they will inherit your tax-free allowance (so long as they’re living in the UK). They will have two £175,000 allowances to pass on to their beneficiaries when they pass (£350,000 total).
This means that if you pass and leave everything to your spouse, with the combined nil-rate band and residence nil-rate band your spouse could have a total £1 million IHT free to leave to their loved ones (£350,000 + £650,000).
However, if an estate is worth more than £2 million, the residence nil-rate band is reduced by £1 for every £2 over £2 million.
RELIEFS AND EXEMPTIONS
There are a few reliefs and exemptions when inheritance tax planning that may be applicable, depending on your situation.
- If you leave 10% or more of the net value of your estate as gifts to charities or a political party, the inheritance tax rates are reduced from 40% to 36%.
- If you consider the UK to be your permanent home, IHT is payable on worldwide assets, however if you don’t consider the UK to be your permanent home (i.e., you are not ‘UK domiciled’) IHT is usually only paid on your UK assets. (There may be IHT rules in your domiciled country).
- People in certain ‘risky’ roles such as the armed forces, fire fighters, paramedics and police are exempt from paying inheritance tax if they die in active service. They are also exempt if they are injured in active service and dies later, even out of active service, if said injury has accelerated death.
Certain types of businesses and investments may qualify for ‘Business Relief’, which allows some or all of the asset to be left to a beneficiary tax-free.
HOW TO MINIMISE AN INHERITANCE TAX BILL?
There are several ways to lessen an inheritance tax bill, including;
- Gifts, trusts and wills: When done right and within allowances, gifts are an easy way to minimise IHT. Some other ways to lessen IHT is through wills and keeping funds outside your estate via trusts (particularly life insurance). The most effective way to minimise tax is with a holistic view to your managing your estate. Click here to read our article on Estate Planning to learn more how gifts, trusts and wills affect IHT.
- Spend more! You’ve made the wealth, why not enjoy it? As much as it would be nice to leave lots of assets to your loved ones, spending more of your estate could lessen the tax bill and give you an even better lifestyle.
This considers careful planning to strike the right balance between enjoying more today and being secure tomorrow, so you should consult a TCFP adviser before implementing this strategy.
- Understand and plan: Knowing the rules and how you can make them work for you is one of the most important aspect of inheritance tax planning. Planning, particularly planning early can make a huge difference between the amount you intend to leave to your loved ones, and the amount that is left (after IHT is paid).
Speak to us to help you better understand and better plan so you can leave your beneficiaries in the best position possible.
REMEMBER YOUR PRIORITIES
Whilst you do not want to hand over a large chunk of your hard earned wealth to the HMRC, you do not want to make sacrifices which negatively impact your lifestyle. Some of the abovementioned ways to reduce IHT may have other costs associated (such as trusts) which may not offset the benefit of avoiding IHT.
A TCFP financial adviser can discuss with you what is best for your personal circumstances, without making sacrifices that could negatively impact your lifestyle. We take a holistic approach to planning your estate, so you can pay as little inheritance tax as possible, and your loved ones can enjoy as much of your estate as possible.
WHAT OUR CLIENTS SAY
“After some intensive fact-finding and analysis, [Jeremy] drafted a financial plan to meet our current and future needs and goals, advising consolidation and moves into the most tax efficient and hopefully more productive investments. We have regular update calls and meetings. He made us aware of the importance of planning around the available tax allowances” – London client (Testimonial from Vouchedfor).
You can find many more client testimonials here.
Great financial planning can change your life.
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