When making a will or making probate arrangements, Inheritance Tax is a big worry for many people looking to leave as much as possible to their loved ones.
Inheritance Tax bills are on the rise – mainly due to increasing property prices. Despite the introduction of a £100,000 tax break in April 2017, the Government took £5.2 billion in Inheritance Tax in the last financial year (an increase of £400 million compared to the previous year) but with a little planning, you can minimise the impact of tax on your estate. Here’s how…
Tax Relief & Thresholds
There are two main tax allowances that determine how much Inheritance Tax you are eligible to pay. The first is a general nil-rate band, which relates to estates up to £325,000 (or £650,000 for married couples and those in civil partnerships). The second is called the main residence nil-rate band which applies to properties that are passed on to children or grandchildren, and is currently worth £100,000. (It’s also worth noting that this band is due to increase to £175,000 by 2020-21.) This second band, introduced in 2017, can be added on top of the general tax band, meaning a potential threshold of £425,000 for individuals (rising to £500,000 for individuals and £1 million for couples by 2021).
One important factor to consider regarding the main residence band is that property must be passed on to direct descendants, which includes adopted/foster/step-children but does not include siblings, nieces, nephews, aunts, uncles or cousins. Other exceptions relate to buy-to-let properties and investment properties that have never been used as a residence by the owner. This band can only be applied to one residence but you may choose which property you apply it to, to maximise your tax savings.
For estates worth over £2 million, the main residence nil-band is also subject to a tapered withdrawal (at a rate of £1 for every £2 over the £2 million threshold). For example, the new allowance would be reduced by £50,000 for an estate worth £2.1 million.
Selling up and buying a smaller (and cheaper) property can help to keep you within the general nil-rate band. This is often a natural move for older homeowners whose children are fully grown and flown the nest, and frees up capital to be used in other ways, such as investments, supporting children to buy their own homes, donating to charity, taking holidays, or making renovations on a new home.
If you choose to downsize to a less costly home, you will still be eligible to claim the main residence nil-rate band, and any surplus within the threshold can be used to pass on other assets so long as you leave your estate to direct descendants.
There is a £3,000 tax-free annual limit on monetary gifts, meaning you can pass on up to £3k per year to loved ones without it being subject to Inheritance Tax. And if you don’t use the allocation it can be carried over to the following year, allowing you up to £6,000 of gifts, tax-free.
Weddings are another great opportunity for gifting cash sums; parents can give up to £5,000 to their children as a wedding gift, up to £2,500 to grandchildren and great-grandchildren, and up to £1,000 to anyone else. So if you’ve got the assets to spare, spread the love!
Other tax-free exceptions include donating to a political party, regular monetary gifts (such as monthly payments to family member) that do not affect your standard of living, and Potentially Exempt Transfers (PET). Potentially Exempt Transfers can be higher than the above gift limits, but – and here’s the trick – must be gifted at least seven years before your death. If you die within this time limit then the value of the gift will be added to the value of your estate and may be subject to inheritance tax if it tips the threshold. There is, however, a tapered relief scale on these kinds of transfers, ranging from 8-40% of tax due.
A little different from the general gift rules, charity donations are eligible for a reduced tax rate of 36% if you leave more than 10% of your estate’s net value to charity. Not only will you reduce the amount of Inheritance Tax you have to pay, you will be leaving a legacy to a worthwhile cause.
Separate life insurance from your estate
Too often, life insurance policies are not taken into account when considering Inheritance Tax, but many payouts are subject to taxation since they are added to the total value of your estate. An additional issue with insurance is that payments may take months to be transferred to your loved ones, leaving them with a shortfall with which to pay tax.
One way around this is to have your insurance policy written in trust, which separates the payout from your estate and therefore negates its eligibility for Inheritance Tax. This also helps to speed up the payout process, meaning your family will receive the insurance sooner than later.
The best way to reduce your Inheritance Tax bill is to consult with your solicitor and draw up a professional, up-to-date will. The help of a solicitor is well worth the modest investment, ensuring that your estate is distributed according to your wishes, the probate process proceeds smoothly and with a minimum of stress, and your loved ones receive as much of your assets as possible.
Try using the HMRC calculator to work out how much you can reduce your Inheritance Tax bill, taking all the above tips into consideration, and get in touch with our family solicitors for more advice on making a will, managing probate arrangements, setting up lasting powers of attorney and keeping that Inheritance Tax bill as low as possible.