Most of us would want our loved ones to inherit our wealth and assets after we pass. Without proper inheritance tax planning, though, they may have to pay hefty inheritance taxes on that wealth.
While some tax is unavoidable, it is vital to get help to plan so that tax bills are kept to a minimum, and your loved ones gain control of your assets with minimum hassle. This blog post offers a quick overview of how inheritance tax works and how to plan for it. Let us begin:
What is the nil-rate band?
The nil-rate band is essentially a personal inheritance tax allowance. What this means is that your beneficiaries do not need to pay inheritance tax if the value of your estate is £325,000 or less. Plus, if you leave your main residence to a direct descendant, an additional “residence nil-rate band” capped at £175,000 till 2028 applies.
Any amount in your nil rate band that goes unused can be transferred to the estate of your surviving spouse and thus increase their overall nil rate band.
Whatever portion of your estate exceeds the nil-rate band is taxed at 40% unless you leave whatever exceeds the nil-rate band to your spouse, registered civil partner or an exempt beneficiary like a charity or a community amateur sports club.
What is the inheritance tax on gifts?
One of the most common ways to reduce inheritance tax is to give money or assets to your beneficiaries while you are still living. Types of gifts that are exempt from tax include:
- Wedding/civil partnership registration gifts (£5000 to children, £2500 to grandchildren, £1000 to others)
- Gifts to spouses or registered civil partners (any amount)
- Small gifts of up to £250 per person per year
- Regular payments out of your income
- Gifts to charities or political parties
- Annual gifts of up to £3000 which is your total personal allowance.
For gifts that exceed these limits, inheritance tax may need to be paid if you die within seven years of the gift-giving, and the value of the gift puts your estate over the nil-rate band. Ask Birdfynn’s accountants about what tax rates to expect on different categories of gifts. They can also help you with efficient inheritance tax planning.
Using trusts to reduce inheritance tax
A good way to ensure your beneficiary gets your money tax-free is by setting up a trust in their name. Essentially, you transfer the money or the asset to a trustee (or trustees) who hold onto it until the beneficiary can assume control (such as when they come of age).
Since it is handed over to trustees, the trust amount technically does not belong to you and thus would not be counted as part of your estate, which can significantly reduce the amount of inheritance tax needed.
How to value an estate during inheritance tax planning
- Valuing an estate involves determining how much the deceased person’s assets were worth at the time of passing and deducting any debts or liabilities.
- Apart from the gift thresholds mentioned above, gifts given in the last seven years need to be included. Gifts from before seven years ago must be included if the deceased continued to benefit from them.
- Costs incurred after passing (such as solicitor or probate fees) can’t be deducted from the estate for inheritance tax calculations.
Who pays inheritance tax?
Generally, the executor of the will or the estate administrator (if there is no will) pays the inheritance tax. Most inheritance tax is paid through the Direct Payment Scheme, wherein funds from the deceased person’s bank account or building society account are used to pay.
The deceased may also have left a whole-of-life insurance policy for paying inheritance tax. By writing the policy in Trust, the tax on payments from a life insurance policy can be avoided. Another option is to pay inheritance tax on the funds raised from the sale of assets.
When does inheritance tax need to be paid?
Inheritance tax must be paid by the sixth month after the estate owner passes. Beyond that, HMRC will charge interest on the outstanding tax amount, even if the executors agree to pay the tax on certain assets in instalments.
A good way to avoid this extra interest is to pay some of the tax amount within the first six months, even if the estate has not been fully valued yet. This is known as payment on account, and if there is any overpayment, HMRC will issue a refund once probate has been given.
How to reduce the amount of inheritance tax to be paid
Some reliable ways to reduce inheritance tax on your estate include:
- Paying into a pension account rather than a savings account (you can nominate anyone to inherit whatever remains in your pension fund after you pass)
- Leaving your estate to your spouse or registered civil partner
- Placing your assets into a trust for your heirs
- Giving away up to £ 3,000 per year in gifts
- Leaving a legacy to charity
Using life insurance to pay inheritance tax
A life insurance policy for inheritance tax payments can simplify things, as it avoids selling your house or other assets to pay the tax.
And when you take out the policy, it can be done ‘in Trust’ so that it is not counted as part of your estate, and thus, any money paid out will go to your beneficiaries and not to your legal estate.
This will help avoid a complicated probate process and that is why it is an important part of the inheritance tax planning process.
The most common form of insurance taken in this context is whole-of-life insurance, which remains in force until the holder passes as long as the premiums are paid regularly.
What other taxes will need to be paid?
After inheritance tax has been paid and the estate has been distributed, your heirs may still need to pay income tax (if their inheritance involves a regular income) or capital gains tax (if they sell what they inherit for more than its original value).
Plus, someone on means-tested benefits who inherits something that would raise their total capital to over £6000 might see their benefits reduced. We always recommend talking to a tax specialist about the tax implications of different types of legacies.
Over to you
In conclusion, it is essential to ensure you are working with a trusty accountant who can plan your finances to keep the inheritance tax to a minimum.
Plus, always make sure that you will clearly delineate where you want your money to go and that you have a reliable executor who will make the tax payments and hand over the rest to the beneficiaries you have named.
Fortunately, our expert inheritance tax planning advisors are here to assist you, whether you are looking to integrate this into a comprehensive tax strategy or simply determining how best to distribute your wealth to those important to you, ensuring they maximize the use of your assets and property.
Please book a free consultation with us to get started.
