If you are fortunate enough to have an inheritance tax liability on your estate, this can be a sore subject. It is a tax on your savings, investments and other assets that have been hard earned throughout your lifetime and often been subject to one of the various taxes already. In addition, you may have already paid inheritance tax on these assets before you inherited them.
Inheritance tax is sometimes seen as a voluntary tax which can be mitigated entirely. However, short of giving away your family home, for those caught by inheritance tax there is likely to be some tax to pay by those surviving you, other than a spouse or civil partner. You may already be familiar with the basics of inheritance tax:
- everybody has a Nil Rate Band allowance of £325,000 for tax year 2018/2019; and
- giving assets away during your lifetime, usually, uses up this allowance first.
The new Residence Nil Rate Band
A recent but complicated addition to the Nil Rate Band allowance is the introduction of the ‘Additional Threshold’, more commonly known as the ‘Residence Nil Rate Band’. Simplistically, this applies when you have an estate greater than the available nil rate band – £650,000 for a couple who are married or in a civil partnership – and you leave your residential property to direct descendants (e.g. children, grandchildren). The complication comes from two main areas: a cap of £2m after which the allowance is tapered away by £1 for every £2 over the cap; and the definition of direct descendants.
Everybody has a Nil Rate Band allowance of £325,000 for tax year 2018/2019
Some trusts work for this purpose and others do not, so it is worth reviewing your will, especially if it involves a trust and was written over two years ago, to ensure that you are making the most of these allowances.
Gifts to family members or friends
Another thing to consider is that you can give away £3,000 a year to others close to you. However, it is important to be aware that this does not mean £3,000 per person but in total. This is known as the annual exempt amount and can be carried forward to the next year – but only for one year.
There are other allowances that can be used each tax year, such as wedding or civil ceremony gifts up to £1,000, rising to £2,500 for a grandchild or great-grandchild and £5,000 for your children.
Other options include normal gifts out of income. This is a simple but often overcomplicated method of helping to mitigate inheritance tax, due to the fact that you must be able to prove that you can sustain your own standard of living after making the gift.
Payments to help with another’s living costs, such as an elderly relative or child under 18, and gifts to charities or (perhaps less popular at the moment!) political parties, are other exempted gifts for inheritance tax purposes.
A useful site to look at before considering making any gifts can be found at www.gov.uk/inheritance-tax/gifts
Whilst the above exempted and small gifts are useful, making a proper dent into your inheritance tax liability is likely to involve gifting larger sums either directly or into trust. There are two types of trusts that people use: bare or discretionary.
Although the variations on these can leave people confused, trusts can be very useful to give the settlor (the person setting up the trust) control over how the assets are distributed long after they are gone.They also provide protection for family wealth by keeping it safe from unscrupulous hands.
Gifting directly is the simplest and cleanest route to mitigating your inheritance tax liability and gives you the delight of seeing those that benefit putting the money to good use, be it grandchildren’s school fees or helping your child onto the property ladder.
However, one aspect of making larger gifts that needs to be considered is the seven year ‘rule’, whereby gifts generally fall outside of your estate for inheritance tax purposes seven years from when they were gifted. You should speak with your solicitor, accountant or financial planner to discuss how this might work for you.
Leaving something to charity in your will is an opportunity that is often missed. Anything left to charity is free from inheritance tax. If you leave at least 10% of your estate to charity, it will reduce how much inheritance tax is due on the rest of your estate from 40% to 36%. Whilst the saving might not be huge, it can mean that your family receive more than they would do otherwise – while your favourite charities also benefit.
Protecting the liability
Possibly the least glamourous option is to take out some life insurance. Whilst this will not reduce any inheritance tax due, it might make it easier for the surviving family to pay the bill without having to sell assets such as the family home. It is important to make sure that this policy is written into trust, otherwise you might make the problem worse.
Inheritance tax planning can be as simple or complicated as you want it to be but it is one of the fastest growing taxes in the UK, as asset prices rise and the allowances and reliefs do not keep pace with inflation. A simple discussion with your solicitor, accountant or financial planner might be all that is needed but remember; the younger you are when you start the conversation, the more effective the planning is likely to be.