To find out whether or not IHT will actually affect you add up the value of all the assets in the estate – such as a house, possessions, money and investments – and deducting any debts held by you such as mortgages, including household bills and funeral expenses. Although Individual Savings Accounts and Personal Equity Plans are not taxable during your lifetime, the assets included in these ARE liable for inheritance tax. If the total value of your taxable assets exceeds the Nil-Rate Band, which is currently set at £325,000, then you should be taking action to minimise your IHT liability. It is therefore very wise to write a will, something we should all do regardless but it is particularly important in reducing an inheritance tax liability. Having a will in place can avoid leaving all your assets to the mercy of intestacy laws.
Reducing the Estate
One of the ways in which you can limit your liability is to reduce the total size of your estate. There are numerous ways of doing this. Many individuals choose to give gifts to family and friends in life rather than writing them into their will gradually reducing their estate. You may wish to think about downsizing your home in order to reduce the size of your property assets. If this is not realistic, you may also consider an equity release scheme – this will free up some immediate cash, which may be vital in retirement, and will again reduce the size of your estate.
More commonly individuals are now turning towards trusts as an effective way of limiting their tax liabilities. Using a discretionary trust you can pass assets on to trust-holders, who are legally charged with looking after them until your death. At this point they will be passed on to your intended beneficiary. This can be an excellent way of pre-empting IHT but of also retaining your ability to determine who benefits from your estate.
However money given away before you die is still usually counted as part of your estate, hence subject to Inheritance Tax, if you die within seven years of giving the gift.
If you make large lifetime gifts, the beneficiaries could take out life insurance against the potential Inheritance Tax bill. Most gifts into trust are now subject to Inheritance Tax even if made during your lifetime, but this is an area where you would need specialist advice.
However, even if you do die within seven years of making a gift, there is a range of other exemptions worth taking into account to help lessen the tax bill:
- Annual Inheritance Tax Exemption. The first £3,000 given away each tax year is completely ignored as part of your estate and thus not subject to Inheritance Tax if you die. If you don’t use this in a year, you can carry it forward for one tax year (no more) and use it then.
- Gifts to charities and political parties are Inheritance Tax free. Any gifts you make to a ‘qualifying’ charity – during your lifetime or in your will – will be exempt from Inheritance Tax
- Give £250 each year to everyone you know. Gifts of no more than £250 to any one recipient per tax year are excluded from Inheritance Tax.
- Gifts from income. Inheritance Tax is a tax on your assets. However if you have an income (pension or earnings for example) and you give money regularly from that which leaves you enough income not to impact your lifestyle, then it is exempt.
- Gifts on consideration of marriage. There are limits to this though: £5,000 for a gift from a parent, £2,500 from a grandparent, £1,000 from anyone else.
- Woodland, Heritage, Farm and Business. If you own an agricultural property that’s part of a working farm then a percentage may be exempt from tax.
Many married couples choose simply to pass their estate on to their spouse but, while this is an understandable choice, it is often not the most tax-efficient course of action. Rather, you may wish to consider placing assets above your Nil-Rate Band into a trust, which is passed to your children, but only after the death of your spouse. This ensures that both your own and your spouse’s Nil-Rate Bands are used effectively, as any transfers between spouses are exempt from tax. If you are interested in this course of action you should consult a professional.
Finally, it should be remembered that IHT rules favour those who are married or are in a civil partnership. Currently, co-habiting couples that are not married will not qualify for the exemption granted those who have legally codified their relationship. Unfortunately, the only way to gain this exemption is by marrying or entering a civil partnership, and this may therefore be an option you may wish to consider.
As we all know there are only two certainties in life – Death & Taxes. However, with a little timely planning the two do not necessarily have to affect your loved ones at the same time. Take some time now to plan your will, and speak with your accountant to ensure that your assets can and will be distributed in accordance with your wishes in the most tax efficient way.