Nothing is certain but death and taxes, as the old saying goes. While you can’t do anything about the former, it is absolutely possible to mitigate the effects of the latter, at least as far as inheritance tax (IHT) is concerned.
What does the current IHT legislation say?
Whatever worldly goods you leave behind when you depart your earthly existence may be subject to IHT before being passed onto your heirs. Your estate is calculated as the net worth of your assets and liabilities including property, savings and investments, business assets, life insurance, vehicles you own and bank account deposits. There’s a nil band threshold for the first £325K, after which a flat rate IHT rate of 40% is applied. It’s a brutally simple system.
Recently, an additional ‘residence nil rate band’ was introduced specifically to benefit the family home. This applies to individuals with direct descendants who leave an estate worth more than £325K. The new nil rate band is currently set at £100,000 but will increase in three annual £25K steps until it reaches £175K in 2020 when family homes will be IHT tax protected up to the value of £500K.
Inheritance tax is a notoriously complex area and, without expert advice, the amount your heirs will have to pay on your estate could be substantial. Nobody wants to pay more tax than absolutely necessary, so is there any way that your estate’s IHT liability could be reduced?
The short answer is yes but it’s definitely not something you should attempt to do on your own. Oliver Spevack of OS Accounting gives this advice:
“I would strongly recommend speaking with a good tax accountant who is not only familiar with the current legislation but who knows the right financial strategies to put in place to minimise your individual IHT exposure.”
Here are 3 great strategies you could implement now to reduce the amount of tax payable on your estate upon your death.
- Giving your money away
Gifting is one way to reduce the value of your estate so that there will be less tax to pay. For starters, you can gift up to £3,000 per year, plus make unlimited gifts of up to £250, and they’re all exempt from inheritance tax.
Did you know that gifting to your married spouse or civil partner is always tax exempt, provided they live in the UK? You can give away any amount at any time and not be liable for tax. What’s more, there are additional tax free allowances for wedding gifts to your children (up to £5K per child) and grandchildren (£2.5K per grandchild). In addition, if you’re contributing to the living costs of someone else out of your spare income, this can also be considered as a tax free gift.
Outside of the above scenarios, you are of course at liberty to give away any of your assets or money to anyone you like, but these will fall under the 7-year rule. These ‘potentially exempt transfer’ gifts automatically become IHT free if you survive for 7 years after making the gift, otherwise IHT is levied on a sliding scale as is shown in the table below.
Finally, you may wish to consider gifting to a charitable cause since charity giving is entirely tax free. Even better, if you bequeath at least 10% of your total estate to charity, your IHT rate for the rest of your estate will be reduced from 40% to 36%.
- Setting up a trust
Many people shy away from using trusts as a tool to tax shelter their estate on account of the complicated rules and regulations that are nigh on impossible to navigate without professional assistance. However, with the help of a specialist solicitor and accountant, trusts can be an excellent solution for reducing your inheritance tax exposure.
While a trust can be set up at any time, you may run the risk of a Capital Gains Tax charge when transferring assets into a trust – unless you establish a trust in your Will, that is. What’s more, the 7-year rule will still apply, though compared to an outright gift you do have more control over what happens to the trust funds. You can specify what exactly you would like the money to be used for, such as paying school fees or supporting a disabled family member.
Just to make it even more confusing, there are different types of trust.
- In a ‘bare trust’ or ‘absolute trust’, the trustees retain full financial control until the beneficiary is 18 years old.
- A ‘discretionary trust’ allows for more flexible (and by that I mean complex) rules that can be tailored to individual circumstances.
- A ‘gift and loan trust’ means that the money can be invested outside of your estate for IHT purposes, but you can opt get the funds back.
Importantly, HMRC requires trustees to review the holdings for IHT every 10 years, meaning tax could in theory be levied straight away. Another reason why you should take expert financial advice.
- Taking out life insurance
Taking out a life assurance policy means that your loved ones will get a payout immediately after your death and, crucially, free from IHT. However, and the importance of this cannot be overstated, you have to set it up correctly. Make sure you take out a whole-of-life insurance policy and write it in trust.
Unless you put your life insurance in trust, the value of the policy will be added to you your estate and subject to 40% tax for anything above the £325K threshold. You will be paying more tax this way, which is the exact opposite of what you wanted to achieve.
Done properly, a life insurance payout can be a godsend just when you’re descendants need it most. The full sum will be paid immediately and without the potential delays involved with inheritance payouts. Your heirs can use the money to pay any IHT bill, in effect reducing the value of your estate for tax purposes.