inheritance tax

10 steps to protect your family from a potential Inheritance Tax bill

Posted on Posted in Finance, Life Insurance, Savings

Inheritance tax comes as an unpleasant surprise to more and more people each year. HM Revenue and Customs (HMRC) took a record £4.6 billion in Inheritance Tax (IHT) in 2015/16. This was up 70% on the previous year.

This frightening growth in tax is due mainly to property prices leaving more people with estates worth more than the £325,000 threshold. The first £325,000 of assets can be inherited tax free – but everything above this is taxed at 40%. Unless you take the right steps now, simply leaving the family home to your children could leave them saddled with debt. To be fair, the government has added a new main residence nil-rate band but this is being phased in, and will only add an extra £100,000 to the threshold in 2017, and is only planned to total £500,000 by 2020.

This means the growth in Inheritance Tax will continue. Research suggests around £550 million will be wasted in IHT this year because people fail to prepare properly. But fortunately, there are ways to avoid Inheritance Tax.

1. Get planning

First you’ll need to work out what those liabilities are. So add up your savings and investments, life assurance and any other assets, including your home. Then subtract £325,000. What you are left with will attract Inheritance Tax.

The family home allowance: There will be a new family home allowance introduced over the next four years, so by 2020, if you own a home your estate would be worth up to £500,000 – or £1m for couples – before IHT kicks in. But be careful – estates worth more than £2m will lose some or all of this family home allowance, and the 40% rate will still be levied.

2. Leave a will – not confusion

A will is your essential tool for avoiding IHT. Without one, assets are handed out according to rules laid down in legislation, and you have no control over who gets what. With a will you can navigate a route through the tax maze, keeping more of your cash intact for those you love.

3. Give it to your loved ones now.

You can give anything you own to your spouse or civil partner, so your estate won’t have to pay IHT on its value. You can also gift your children if they are in full-time education and the money goes towards the cost of their education or their maintenance, which can include paying off their student loan.

You can’t unfortunately give them your home. It would not be considered their property unless they took possession of it – which might mean turfing you out.

If you give property or cash to anyone else the value of the gift will be included in your estate for IHT, for seven years. You can give cash or gifts worth up to £3,000 each tax year, providing you live for seven years after giving.

4. Give it to charity

As a concession to encourage charitable giving, gifts left to recognised charities are free of IHT. If you leave 10% of your estate to charity, your overall IHT bill will drop from 40% to 36%. This isn’t a very large saving – the taxman still takes a big cut, but it could mean your family and friends receive more than they would do otherwise, and your favourite good causes can benefit too. 

5. Downsize and give your children the cash

You can’t give away an asset such as property and then continue to live in it without running into “gift with reservation” rules. These mean either paying market rent to the new owners (probably your children) or to find somewhere else to live. This is to prevent “deathbed” giving as a way to avoid the tax. However, you could downsize and give some of the cash released to your loved ones – if you stick to the limits and you live for another seven years.

6. Invest in inheritance tax proof assets

You can build IHT proof assets, based around an ISA and made up of certain classes of shares, such as those on the Alternative Investment Market (AIM). You can pass these on without IHT, but they can be difficult to set up without expert advice – especially as there is no definitive list of ‘safe’ companies to check. The taxman makes a judgment on whether a company is exempt only when the tax is due, which can add to the worries your beneficiaries face.

7. Create a trust

If you put cash, property or investments into a trust (which you, your spouse and none of your children under 18 years can benefit from) then they are no longer part of your estate. You might set up a trust for your grandchildren, or to support another family member, for example. You can set one up now or establish one in your will.

8. Use a deed of variation

If a grandparent dies leaving everything to children who are already well off, it may simply build up the burden of IHT for the next generation. This can be avoided if the grandparents’ will is changed via a measure known as a variation. Passing assets straight on to the grandchildren can mean less IHT is paid overall, but this kind of deed of variation requires the consent of every beneficiary mentioned in the first will, and needs to be completed within two years.

9. Don’t spend your pension

Any funds in a pension pot can be passed on to a named individual without any tax implications if you die before the age of 75.  So if you have more than one source of wealth, it could pay to spend non-pension income in retirement and leave your pension pot to be passed on intact.

10. Insure against IHT

There is a very simple way to beat IHT. Take out a ‘whole of life’ insurance policy and make sure it is written under trust for your heirs, and will pay out enough to cover your IHT bill. Because the policy is written under trust, it’s paid out free of Inheritance Tax, and your heirs can use the pay out to pay the IHT bill as soon as it’s due.

Inheritance planning is complicated, and it is essential to get professional advice to reduce your Inheritance Tax bill. Contact our financial planning team today to explore your options