Life is made for living and focusing too much on managing the future of your wealth can mean that you miss out on the rich experiences that life has to offer. With this in mind, there is no harm in spending your money and enjoying your lifestyle whilst following this guide to ensure that the last cheque you ever write is the first one that ever bounces. This means setting out your estate in such a way that your inheritance tax liability upon death is zero. It is important to consider how to optimally structure your estate to limit inheritance tax liability and ensure your assets and wealth can be passed to your spouse, descendants or chosen beneficiaries when the time comes.
Our clients often make enquiries alluding to the best way to structure things when a relative has died and often, the wider family are involved in a process which can sometimes be incredibly complicated. In this guide we will discuss the rules or probate and intestacy, highlighting how making sensible plans early on can save a great deal of difficulty further down the line.
In order to calculate inheritance tax, the entire estate of the deceased individual is added up. A 40 percent charge is then levied on any portion of the estate which is above the nil rate band which is typically £325,000 per person. You may think of the nil rate band as an allowance within which no inheritance tax is chargeable. If the individual is married, they can combine their nil rate band with their spouse to a total of £650,000. In addition to this, the Main Residence Nil Rate Band adds an extra £175,000 to this total and is designed to protect the family home from inheritance tax liability. In order to leverage the benefits of the Main Residence Nil Rate Band, the property must go to direct descendants and the value of your estate when you die must be less than £2 million.
Without a will, you will die intestate meaning your estate will be divided in accordance with the statutory rules of intestacy which follow a hierarchical structure starting with your spouse and filtering through close relatives in priority order. Will planning is important as it gives you control over who receives which elements of your estate upon death. A typical will states that the value of the estate should, in the first instance, be passed to the individual’s spouse and if the spouse pre-deceases the individual, then the estate should be passed equally to his/ her children. You are however free to decide who receives what, if any, of your estate upon your death. It is worth bearing in mind that if you leave at least 10 percent of your net estate to charity then the inheritance tax rate is 36 percent as opposed to 40 percent.
Aside from a will, you can also create a lasting power of attorney which appoints someone you trust to make decisions about your affairs on your behalf in the event that you are unable to do so yourself at a later date. You can read more about this on our website.
Lifetime gifts can be an effective way of reducing the value of your estate and thereby limiting your inheritance tax liability. Gifts are potentially exempt from inheritance tax if you survive for 7 years after making the gift. In the event that you do not survive for 7 years, it is necessary to look at the relevant exemptions. Firstly, the spouse exemption allows for unlimited gifts between UK domiciled spouses. Secondly, you have an annual gift exemption of £3000 per year. Finally, any gifts to charity are also exempt. In parallel to retirement planning, it can be beneficial to begin considering whether making small and regular gifts will eventually mitigate inheritance tax liability ensuring that the beneficiaries of your estate receive more than they would have after inheritance tax deductions. Regular gifts out of income must be out of surplus net income after tax and must not deplete the standard of living. Consider how much you can afford and build a financial plan based upon this. It is also worth bearing in mind when gifting a property, capital gains would be payable at 28 percent on the growth in value of that property as it would be considered to be transferred at market value.
Trust planning can offer an alternative to passing property directly and losing control of the asset. The individual looking to make the gift would lose the income from the property but they can maintain control and may even be able to sell that asset to buy another. In this situation, the capital gains tax is slightly different and you would be able to defer the tax until the property is sold however from an inheritance tax point of view, you have given the property away and you have survived the gift of 7 years.
Finally, some may elect to put family investments inside a company which may be composed of a share portfolio and rental portfolio. The benefit from an inheritance tax point of view is that if one of the shareholders dies, then only their share will be considered part of their estate. Also, as the value of the company grows, the future growth is shared among the family so this is a good way to structure the shift of value to the other members of the family.
Investing in an Inheritance Tax-Efficient Manner
The money you have already paid tax on will be that which is then invested for your future therefore it is sensible to ensure your investments are inheritance tax efficient to avoid double taxation. Investments into business property relief qualifying investments, pensions or placing capital investments into trusts can offer a host of benefits and you can then insure the tax liability on your estate.
Business property relief investments can be higher risk but they allow the investor full access and control and because of the risks associated, they become exempt from inheritance tax if you have held them for 2 years.
It is common knowledge that ISA accounts are a very tax efficient way of saving money however the reality is that they end up becoming part of your estate in the event of death so you would end up paying tax on them anyway.
There are a number of other potential ways to sensibly invest your money but always ensure that you diversify your options as one solution is rarely the right solution.
With regards to pension funds, they can now be passed to other family members on death without inheritance tax charges. Ultimately, some pension funds will be eligible for income tax relief on contributions and the default position will be to leave the pension fund to their spouse but in actual fact, your spouse might not need the pension fund so it may make more sense to name your children as beneficiaries of your pension fund who can draw income on the pension fund at their own marginal rate of tax. Pension money is likely to be seen cascading through generations as a result of the new inheritance tax rules.
Loan trusts can operate by way of a loan being made to a trust which you have established. Once the loan has been made to a trust, you then have an entitlement to repayment of that loan however inheritance tax would only then be due on the crystallised amount of the amount originally loaned, leaving any growth upon that sum outside of your estate for inheritance tax purposes.
Finally, it is possible to insure potentially exempt transfers which cover inheritance tax liability on a specific gift (inter vivos insurance) in addition to insurance for the whole of life whereby policy proceeds would be designed to pay inheritance tax due. Be sure to think about the cost of nursing or care in your old age and how this will be funded. Increasingly, we see clients contemplating equity release to make a gift to their family, especially considering interest rates are historically low.
So, in conclusion, what should you do now to begin preparing your affairs and estate for the future?
- Start by understanding how inheritance tax could affect your estate and how you could restructure your finances and assets to control the amount of tax you will need to pay.
- Create a will and a lasting power of attorney
- Consider insurance
- Put together a financial plan for the future
- Work with lawyers, tax advisers and financial planners to help you achieve the optimal outcome.
If you would like to discuss your options in relation to creating a will or trust, our wills, trust and probate solicitors have a wealth of experience dealing with a wide range of services and can offer expert advice and guidance. Please call us on 0330 128 8888 for a free initial consultation.
