The death of a loved one comes with all sorts of stresses and emotions. For many people, the last thing they want to do is deal with wills and estates. Nevertheless, without taking the appropriate steps, inheritance tax could end up costing you hundreds of thousands of pounds. So, all matters relating to it must be dealt with efficiently and promptly.
It is possible to reduce your inheritance tax liability or, in some cases, to pay nothing at all. Here we will look at some of the things to consider when inheritance tax planning to make sure you receive what you are entitled to from your loved ones’ estate.
To start with, we shall take a look at what inheritance tax is.
What is inheritance tax?
In short, inheritance tax is the amount of tax you are required to pay the government on assets left to you after somebody passes away. Two major factors determine whether you can avoid paying inheritance tax in the UK:
There is usually no inheritance tax to pay if:
- The value of the estate is under £325,000
- Anything over £325,000 is left to a spouse, civil partner, amateur sports club or charity.
The UK inheritance threshold increases to £475,000 if you leave your property to your children or grandchildren.
UK inheritance tax is set at 40% of everything over the above thresholds; so an estate valued at £500,000, taking away the tax-free value of £325,000 would mean inheritance tax is due on the other £175,000 – a tax bill of £70,000! If the property is left to your children, the tax-free element would be £475,000 leaving inheritance tax obligations of £10,000.
Remember, though that these are just the simplified figures. To demonstrate how inheritance tax works and why it is so crucial that you do not leave it to chance. There are many other factors which will be used to calculate the amount of inheritance tax you pay, and these will be discussed below.
Inheritance Tax Planning
UK Inheritance tax: How much is my estate worth?
In the previous section, we referred to the standard inheritance tax thresholds, which are based on the value of your estate. Your estate is essentially the total value of all your assets at the time of your death.
Like all things to do with tax laws, though, it is more complicated than that, and you should always seek advice from qualified legal practitioner when making inheritance tax plans.
Assets are defined as anything which has an intrinsic value and includes things such as:
- Cash held in a bank account
- Investments; stocks, shares, bonds or mutual funds
- Properties that are owned or partly owned
- Business interests
Any proceeds from a life insurance policy
Some of these listed, such as investment or business interests, can be hard to value, and a legal professional should only do this. Even more complicated is the fact that HMRC also expects you to value every gift made in the seven years before your death to find the total value of your estate. Once again, a gift is classified as anything with an intrinsic value and includes property and money. However, some gifts are exempt from inclusion.
You can give cash gifts to loved ones of up to £3000 per tax year which are free of tax.
Christmas and birthday gifts of up to £250 are also exempt as are gifts for a wedding or civil ceremony up to the value of £5,000 for your child, £2,500 for a grandchild and £1000 for anybody else.
Once you know the total amount of assets at the time of death and the overall value of gifts given in the seven years prior to death, you simply add the two together to get the total value of the estate.
Next, you need to account for any debts or liabilities such as mortgages, outstanding bills and any funeral cost. You then subtract the total liabilities from the total value of the estate to find the net value of the estate against which inheritance tax liabilities will need to be paid.
Next, we shall look at the Main Residence allowance.
What is the Main Residence allowance?
It gives certain allowances if a child, step-child or grandchild of the deceased has a property passed down to them, and is using that property as their primary residence.
Each tax year, the main allowance threshold increases. In the 2019/20 tax year, the allowance allocates an additional £150,000 on top of the current threshold. So in addition to the £325,000 single estate threshold (or £650,000 if married), you receive an extra £150,000 before you are liable for inheritance tax. In 2020/21 the allowance threshold will increase to £175,000.
It is worth noting here that if you are the beneficiary of an estate worth over £2 million, you are eligible for all of the allowances mentioned up to £2 million but for everything above that figure then homeowners will lose £1 for every £2 in allowance.
Do I still need to pay inheritance tax if I am married?
UK tax laws often make concessions when it comes to married couples, and inheritance tax is no exception. In simple terms, if you leave your estate to your spouse or civil partner, they will not be expected to pay inheritance tax. Moreover, as you have not used any of your allowances, this is passed on to the beneficiary and serves to increase their allowance upon their death.
Let us see how this works:
For this example, we will assume that you and your spouse have a total of £1 million in combined assets.
When you pass away, your assets are passed to your spouse. You would have otherwise had an inheritance tax allowance of £325,000, plus the £150,000 from the central residence allowance making a total allowance of £475,000. When your spouse or partner dies, they would have an allowance of £475,000, but as yours was not, they take that as well, meaning their total allowance is £950,000. This means inheritance tax liability will only fall on £50,000 of their estate. The total amount that can be passed on, though, is based on the proportion of the allowance utilised at the time of your spouses’ death.
How can I reduce the amount of inheritance tax I pay?
If what you have read above sounds complicated, do not worry. That is why you need to use a specialist advisor or solicitor for inheritance tax planning. However, hopefully, this guide will give you a satisfactory overview of how it works and some of the things you can do to avoid overpaying. Furthermore, that is what we will look at in this section.
One of the easiest ways to reduce your inheritance tax liability is with the gift rule. So let us look at some of the most popular gifts and how they can be used to reduce it.
The 7 Year Rule
As stated earlier, this simply means that the value of any gifts given (other than exempted gifts) over the seven years before death form part of the value of your estate. This means that if you give gifts to your children but then live beyond seven years from the time you give them, your children will pay no inheritance tax on them so you can actually give away a significant proportion of your estate in this way and potentially reduce your inheritance tax liability by a considerable amount.
If the value of the gifts is of significant value, the beneficiary can take out a life insurance policy to protect them if you pass away within the seven years.
It used to be thought that placing funds in a trust would avoid inheritance tax, but this is not the case. Most trusts are liable for inheritance tax, and you would need to consult a specialist if you were hoping to avoid it using this method.
While all gifts given away at least seven years before death are exempt from inheritance tax, other reductions are allowed in certain circumstances if you do not live long enough for the seven-year rule to come in to play. You will start to reduce the inheritance tax liability on it as soon as the gift is given and, as you will see, the reduction then increases as each year goes by.
|Years between gift & death||Tax paid|
|less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
Another option is to simply give annual gift payments of £3,000, which will add up over the years but are free of inheritance tax liability.
There is also a £250 gift allowance scheme in addition to the £3000 gift payments. This means you can give gifts of up to £250 to as many people as you want every year. So, for example, if you have four children and 12 grandchildren, you could give each of them an extra £250 annually, meaning you reduce your liability by an extra £4000 each year.
Giving to charity is another way of reducing inheritance tax as the 40% standard rate of inheritance tax is reduced to 36% if at least 10% of your assets are left to charity. Again, this is best discussed with an inheritance tax expert before you make any decisions. Moreover, do not think this is a way of making sure more money goes to your beneficiaries as they will receive less than they would even if the full 40% was paid, but if you were planning on leaving money to charity anyway, it is definitely worth looking in to.
As you can see, inheritance tax is an incredibly complex and complicated area to manage, but with the right advice, it is possible to massively reduce your liabilities and thus make sure that more of your hard-earned wealth goes to those you love the most. If you want to talk about how you could start to reduce your inheritance tax liabilities get in touch and one of our experts will guide you through how you can use the above allowances in your particular circumstances. Visit Qredible.co.uk to find an inheritance tax solicitor.
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