Inheritance tax (IHT) is becoming an issue for an increasing number of people in the UK. None of us likes to entertain the thought of our own death and what would happen to our family after such an event. However, a financial plan for your death is vital, especially if you have dependants.
IHT is a tax on money or possessions you leave behind when you die and on some gifts you make during your lifetime. However, a certain amount can be passed on tax-free, utilising your ‘tax-free allowance’. This is also known as the ‘nil rate band’.
Everyone in the current 2013/14 tax year has a tax-free IHT allowance of £325,000. The allowance has remained the same since 2010/11 and will stay frozen until at least 2018.
Failing to think about how to tackle a potential IHT liability could have serious consequences for your loved ones. No one wants to leave people they care about with an IHT bill that could have been substantially reduced, or even eliminated altogether.
We have provided five steps to consider if appropriate to your particular situation:
1. Write a will
In the UK, if you don’t have a will your estate will be distributed according to rules set out by law. These are known as the ‘Rules of Intestacy’ (some areas of the law and legal procedures are different in Scotland).
For example, in England and Wales, if you’re married with children, the first £250,000 of your estate (plus any personal possessions) would pass to your spouse. The remainder would be split equally, half going to your children when they reach the age of 18 and the other half used to generate an income for your spouse, passing to the children on your spouse’s death.
If you’re not married your estate will go to your blood relatives, even if you’ve been living with someone for several decades. This could be far from what you wish. Think about where you want your money to go and why. A will makes your wishes concrete and clarifies who should get what, but can also be reviewed over time.
2. Making use of life assurance
Life assurance can play a big part in your IHT planning. Rather than reduce the liability, by taking out a plan to cover your estate’s potential IHT liability and writing it in an appropriate trust, the proceeds can be used to meet the IHT amount payable. More importantly, by putting it in an appropriate trust it will fall outside your estate so it won’t form part of your estate and will not be liable for IHT currently at 40 per cent.
3. Give it away
Giving your wealth away to another individual while you are still alive will also save on IHT. Some gifts are immediately outside your estate. You can give as many people as you like up to £250 each in any tax year. If you want to give larger gifts, either to one person or several, the first £3,000 of the total amount you give will be exempt from IHT with the balance after 7 years.
You can also make a regular gift as long as it is out of your income and doesn’t affect your standard of living. For example, if you don’t spend all your salary or pension each month, you could redirect any funds that are left over to another person. The gift does need to be regular, which could perhaps be a birthday or Christmas present, or a monthly payment.
A wedding can also be a good excuse for an IHT-exempt gift. A parent can give up to £5,000, a grandparent £2,500 and anyone else £1,000.
Legislation stops the tax saving if you continue to benefit from whatever is given away.
4. Make an investment
and use a trust
This could be useful if you wanted to give some money to, for example, your children or grandchildren but fear they might not spend it wisely during their teenage years. Or, if you wanted to give away capital while keeping control over how it is managed and, in some instances, still being able to receive an income from it.
Tax charges can also come into play on the money placed in trust, but generally if this remains below the nil-rate band you won’t need to pay any tax. And in many cases the level of tax suffered will be less than the 40 per cent headline IHT rate. Most IHT planning uses a trust arrangement of some sort.
5. Make IHT-exempt investments
Where planning to reduce the liability is not possible, then life assurance is an option. More importantly, by putting it in an appropriate trust it will fall outside your estate so it won’t form part of your estate and will not be liable for IHT, currently chargeable at 40 per cent. Be aware that premiums must be maintained throughout your remaining lifetime and if they lapse, so will the cover. It’s therefore essential that you ensure the continued affordability of the premiums, which may be payable for the rest of your life.