We all know the saying - “two things in life are certain, death and taxes.”
Unsurprisingly, thinking about the tax due when you are no longer here isn’t always at the forefront of our mind. However, for certain people inheritance tax planning can be vitally important when it comes to leaving a legacy to your beneficiaries.
So, what exactly is inheritance tax (IHT) and why should you care?
Inheritance tax (or sometimes known as the ‘Death Tax’) is a tax which could be payable to HMRC on your estate.
Everything that is owned by a person when they die is known as their estate. This will include their money, property and possessions. Based on the size of the estate, inheritance tax may need to be deducted. This means that the eventual beneficiaries may receive less than expected.
Nil Rate Band
UK residents will have their own Nil Rate Band of £325,000, which usually means that no inheritance tax will be payable providing their estate does not exceed this amount. It is important to note that IHT would not be payable when passing assets to your spouse/civil partner.
In addition to this, any unused Nil Rate Band can be passed on to your spouse. For example, if Mr Bloggs dies and passes all of his assets to Mrs Bloggs, he is not using any of his Nil Rate Band. Therefore, Mrs Bloggs would have a Nil Rate Band of £650,000 available on her death.
It is also important to know that inheritance tax would not be payable if the estate was being left to a charity.
Although the Nil Rate Band may sound like a substantial amount, in reality it is common for someone’s estate to exceed this amount. According to the Office for National Statistics (ONS), the average UK house price in 2020 increased to £256,000. Now, depending on where you live in the UK it is very likely that the price of your home is actually in excess of your Nil Rate Band.
Residence Nil Rate Band
To combat this, the Government introduced a further allowance called the Residence Nil Rate Band. Over the last few years, the Residence Nil Rate Band has increased to £175,000 per person. The Residence Nil Rate Band sits on top of your Nil Rate Band but can only be applied if you pass the property onto ‘lineal descendants’ on death. This includes:
- biological children,
- adopted children,
- fostered children, and
Similarly, any unused Residence Nil Rate Band can be passed on to a spouse on death.
This means that theoretically a couple may be able to protect up to £1m of their estate using these allowances.
How do I reduce my inheritance tax?
In order to reduce inheritance tax people may give away some of their estate by way of a gift whilst they are still alive. This is a common way of reducing your estate. However, care must be taken as gifts made within seven years prior to your death may still be included in your estate and therefore liable to IHT.
In addition to this, once a gift has been made you relinquish ownership of that asset and consequently lose control of it.
For this reason, many people look for alternative methods of removing an asset from their estate whilst retaining some form of control of the asset. The following solutions could be considered in some circumstances: -
- A Discounted Gift Trust (DGT) - this is an Investment Bond arrangement which allows individuals to undertake inheritance tax planning without losing full access to their investment. A gift is made into a trust for the ultimate benefit of the beneficiaries. Whilst the settlor does not have direct access to the capital, they will have the right to regular withdrawals.
- Business Property Relief (BPR) - certain investments which qualify for BPR can be passed on free of inheritance tax on the death of the investor, providing the shares have been held for at least two years. The ‘seven-year clock’ is therefore reduced by five years and means the individual does not lose control of the investment.
- Flexible Reversionary Trust - another trust-based Investment Bond arrangement which allows the settlor to gift money into a trust thus starting the ‘seven-year clock’ on the gift. However, the settlor also retains access to flexible periodic payments.
Inheritance tax planning is often a complex area and it is recommended that independent financial and legal advice is sought. There are a variety of solutions available which can help you to mitigate the sting of IHT.
The government received £5.2bn from inheritance tax receipts in 2019/2020 and current tax legislation could face changes over the coming years as the UK tries to recover from the effects of COVID-19. Therefore, inheritance tax planning could become even more important.
If you would like to discuss inheritance tax planning or your financial arrangements in general, please do not hesitate to contact on 01206 217329