When you die, you may want your estate to be passed on to your children – however, Inheritance Tax (IHT) can significantly take away from the amount they receive.
Inheritance Tax is a tax paid on the total value of the estate left behind following death, accounting for everything from savings and investments to cars and houses.
There have been a number of cases in which children have had to foot the bill for hundreds-of-thousands of pounds in Inheritance Tax – money which, they may feel, is rightfully theirs.
Luckily, by planning for IHT, there are ways in which you can reduce (and in some cases eradicate) Inheritance Tax.
When talking about Inheritance Tax, the term ‘estate’ is used regularly – but what is it?
An estate comprises of everything that determines an individual’s net worth, accounting for all of their possessions (both tangible and intangible). Some of the most significant items in an estate include:
The administration involved with planning the distribution of an estate is known as ‘estate planning’ and is one of the most important ways to prepare loved ones for life without you.
In the UK, the Inheritance Tax threshold is £325,000 for an individual – this is known as the nil-rate band. This tax-free allowance increases to £650,000 for married couples, when the first to die leaves the entirety of their estate to the surviving partner.
Any inheritance received that is valued higher than £325,000 is subject to a tax of 40%.
There are certain other scenarios in which the threshold for Inheritance Tax can be reduced. These include:
A reduced rate of 36% on selected assets is allowed when at least 10% of the person’s net value is left to charity. This would mean that your chosen beneficiary would receive less than they would if paying the usual 40% tax, but in terms of value, the donation would still reduce the amount paid in IHT.
When a significant gift is given (such as a car, property or large cash sum), Inheritance Tax can be charged up to 7 years prior to death. The closer to death this gift is given, the more IHT will be owed. Rates range between 8% for 6 or 7 years and 40% for any gifts received within 3 years of passing. Some gifts are exempt from IHT, which we will elaborate on under ‘Inheritance Tax exemptions’ below.
Any business you own shares in is included when calculating the value of your estate, but business relief of up to 100% is available on some assets. This includes property and buildings, machinery and any unlisted shares.
The only true way of calculating how much Inheritance Tax will be owed when you hand over your estate is by calculating its total value.
This should account for any of your assets such as property and investments, life insurance policies which haven’t been written in trust (more on that later) and cash. You should also calculate your liabilities such as loans, overdrafts, credit card bills and the outstanding mortgage on your home.
The best way to work out inheritance tax is by using an Inheritance Tax calculator – but before you do, read on to find out about some potential exemptions.
One of the most important aspects of estate planning is understanding what you are able to hand over without being charged IHT. Some examples of this include:
Insignificant gifts (less than £250) do not usually qualify for IHT, while there is also a £3,000 limit on gifts per person each tax year. Exemptions also include wedding presents (up to £5,000), regular gifts based on your income (eg. Christmas/birthday presents) and financial gifts which assist with somebody’s living costs (such as an elderly relative or family member under the age of 18).
Farms can be passed over without IHT being charged on the value of the land, but the tax will still apply to other assets like equipment and machinery.
By writing a life insurance in trust, it is excluded from the total value of your estate and won’t be affected by Inheritance Tax. Setting up a trust fund to avoid Inheritance Tax can be done alongside writing a will and could help you and your family to save thousands of pounds.
Any donations left to charity in a will are exempt from Inheritance Tax. Leaving a donation to charity, as discussed earlier, will also entitle other beneficiaries to a reduced IHT rate of 36%.
One way to avoid IHT on the value of your property is to give it away at least 7 years before you die. This will require you to move out of the home, unless you continue to rent it from the new owner.
For example, you could gift the home to a child who would then take on the responsibilities that come with being a landlord. You would still be required to pay rent at an accepted going rate and contribute towards any bills and must live in the property as a tenant for at least 7 years to avoid Inheritance Tax.
Another option would be to give away only part of the property, which could take away from the overall financial value of your estate and help to avoid Inheritance Tax – this would still need to be done at least 7 years prior to death.
To ensure that your loved ones receive exactly what you wish them to following your passing, it is vital that you have a plan in place to minimise the impact of a potentially hefty death tax bill.
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Our friendly advisors at Wills Services are on hand to offer expert, no-obligation advice to help make sure that no stone goes unturned when it comes to planning for Inheritance Tax and the future of your loved ones.