It’s going to happen to us one day, and sadly there is very little we can do about it. That said, we can prepare financially and make sure once we’re dead, our money does not merely go to the government in the form of Inheritance Tax.
Minimise Your UK Inheritance Tax Liability
The first step of any Inheritance tax planning is to make a “Will” to make sure your assets are distributed in line with your wishes. Without a will, your assets will be distributed in line with intestacy rules in the UK and could be liable to inheritance (IHT). If your assets are fairly simple, you can pop to your local news agency which will probably have a “will template” that you can complete at home. If your assets are more complex due to owning your own business or extensive property assets, then you may need to seek the help of a solicitor to develop your Will.
Who Should Benefit and By How Much?
This is such a tough decision, especially as there will always be someone unhappy with what you decide. Sometimes it doesn’t even come down favouritism, but who you think will benefit from your wealth the most. Or will spend or invest it most wisely.
As a frightening prospect as it sounds, one of the best ways to deal with it is to have a conversation about it with the entire family. Explain to them your reasons for dividing the money as you are and perhaps give them the chance to have their say. If there is too much friction, you can always share the money up equally between your more immediate family members.
One common way of doing this is to give a small fixed amount to your grandchildren and divide the rest equally between your children. If you are worried about any old grudges the meeting could dig up, you may consider bringing a financial advisor along who can act as a mediator. In this guide, we’re looking at ways how to avoid inheritance tax in the UK
Nil Rate Band
It is important to note first and foremost that each individual benefits from a nil rate band (NRB) which currently stands at £325,000. You will not pay Inheritance Tax (IHT) on the first £325,000 of your estate.
Married couples and those in a Civil partnership have a combined total band of £650,000 as the deceased spouse’s band is transferable in the event of death. Note that you can benefit from a maximum of two bands. In theory, anything over the band will be subject to 40% IHT.
Gifts “The Seven Year Rule”
As we mentioned earlier, each individual can benefit from a £325,000 NRB, and it is crucial to clearly plan and implement an IHT strategy for anything above this figure at your earliest convenience.
One such beneficial solution to make use of is the ‘Seven-year rule‘. Under this rule, you can make ‘Potentially Exempt Transfers’ (gifts) to your children and family for which they will not have to pay IHT as long as you live for a period of 7 years from the date of the gift.
If you were to pass away within the seven-year period, the gift would become known as a Chargeable Transfer. Any gift outside of the NRB made within three years, or less of your death will be subject to 40% IHT with this percentage diminishing to 0% in line with the number of years since the gift was made, this is known as “Taper Relief”.
Other ways to distribute your wealth and avoid paying tax include giving money as a gift under the following conditions;
- Married Couples – are allowed to transfer assets between themselves during their lifetime or upon death
- Small Gifts – you can gift anyone you want up to £250 each tax year
- Annual Exemption – you can give up to £3,000 worth of gifts each year without being subject to IHT. As a benefit, you can also gift any unused allowance from the previous year.
- Weddings – you can give your children up to £5,000, your grandchildren up to £2,500 and one else, a gift of up to £1,000 for their wedding.
Giving a sum of money totalling 10% of the net value of your estate whilst you are alive, or written into your Will, to a registered Charity, will reduce any IHT payable within your remaining estate from 40% down to 36%. The charitable contribution will not be subject to IHT.
If you have your own company and it’s going to be part of your estate, business relief could offer you a solution to make sure you’re not liable for IHT tax. While there are a selection of qualification rules, if the deceased had owned the business or asset for at least two years before they died, you might be able to pass on a family business without being subject to an IHT charge.
Like all parents, you want the best for your children and grandchildren. Setting up a junior ISA or a junior pension has the benefit of providing for your children’s future but can also be part of your IHT Plan. One point, the seven-year rule from above does apply in this situation.
- Junior ISA’s – are both tax-free and allow you to add up to £4,368 per year for children that are under the age of 18.
- Junior Pension – You can add up to £2,880 to their pension’s each year and receive 20% tax relief from the government. As a result, £3,600 each year
Set Up A Trust
This is where things start to get rather complicated and therefore, we would highly recommend that you seek out the help of a financial adviser who can advise you on the best course of action. In principle, a Trust works by allowing you to save tax while keeping control of your assets via a set of trustees who will make a decision on when and to who the trust is distributed.
One point, you can make a gift into a trust from your estate at any time; however the seven-year rule does apply, even though technically, you now don’t own the assets, the trust does. Across the market, there’s a selection of different trusts that you could potentially set-up depending on what you’re trying to achieve. Each type of trust will be taxed differently, however, they all involve a Settlor, Trustees and a Beneficiary.
The most common trust is a Bare Trust which is commonly used to pass assets to children once they’re old enough to take responsibility. In this example, the assets are held in the name of the trustee, however, the beneficiary has the right to the assets at any time once they’re 18 or over (in England and Wales), or 16 or over (in Scotland).
Lastly, rather than worry trying to reduce your IHT liability through different methods, why don’t just get on and enjoy your money. Spending it will reduce the value of your estate and therefore the IHT liability.
One point, you need to spend the money. There’s no point in buying investment items such as cars, wine or artwork. You might be spending your money, but these expensive items will stay in your estate and be part of your estate when your IHT liability is calculated. You need to spend your money on holidays, dinners and enjoying your time with your family to reduce the value of your estate.