Inheritance Tax (IHT) planning is often an area a number of our clients require further assistance with, but this does not come as a surprise as IHT rules can at times be quite complicated. Our Manchester based independent financial adviser, Paul Tuson, takes a closer look at some of these IHT rules.
There is a common misconception that IHT only applies to extremely wealthy families, but this is not the case. With rising property prices, many families could be facing an IHT bill. In fact the amount of IHT collected over the past five years has doubled, and over the same period the number of estates paying IHT bills has tripled.
If your estate does have an IHT liability, your beneficiaries will have to pay this bill on your death.
There are many ways within your lifetime that you can plan to take care of any potential IHT problems, but finding the right option for you will depend on your personal circumstances.
In short, IHT is paid on the value of the assets that a person leaves behind when they die. It can however apply to gifts that are made before someone dies.
When you die your ‘estate’ consists of the assets you leave behind. If you are married or have a civil partner you can leave your entire estate to your spouse or civil partner free of IHT. If, however you wish to leave your estate to family or friends then it may be liable for tax. If your estate is worth more than £325,000 (known as the nil rate band) then HMRC will expect you to pay IHT at a rate of 40% on the total value of your estate over the nil rate band.
Your marital status however can mean that the rules are quite different. If you are single, then the rules above apply. If you are married, or in a civil partnership, then as mentioned already your assets can be transferred to them without any IHT to pay.
Also, leaving assets to a spouse does not use up your nil rate band, effectively making the nil rate band of the surviving spouse £650,000. Note: if you have a partner but you are unmarried, you are treated as single for IHT purposes.
Don’t fall foul of the IHT trap. Speak to your financial adviser before making any decisions.
Residential nil rate band
This new additional IHT allowance was introduced in 2015, and is effectively attached to your main residence. This is currently an additional £125,000 rising by £25,000 every April until 2020 when it will be £175,000 (£350,000 per couple). Adding this to the £650,000 nil rate band equals a £1 million IHT threshold.
There are some rules and conditions surrounding this. The main one is that the property must be left to direct descendants i.e. children or grandchildren. However, the residential nil rate band is limited to the value of the property in question, so if your property is worth £250,000 then this is the maximum that can be used against it.
Leaving pensions as part of your estate
In 2014, changes were made to how IHT applies to some pensions. Whether or not your estate benefits will depend on the type of pension you have and the age at which you die.
- If you have a defined benefits pension (final salary) this means you will have a fixed percentage of your final salary at retirement, payable over your lifetime. The pension continues to be paid to your spouse if they survive you. It cannot be left to anyone else in its current form after you die.
- If you have a defined contribution pension and it has not been taken as an annuity it’s likely to be left to your beneficiaries if you haven’t drawn it completely when you pass away. This undrawn pot can now be left free of IHT to your beneficiaries, however it would be income tax payable by them at their prevailing rate of tax if you die after age 75. If you die before 75, no Income Tax is payable.
The current rules relating to pensions are complicated, so please speak to your financial adviser before making any decisions.
Making gifts to reduce your estate’s value
You can gift £3,000 annually per annum, wedding gifts of up to £5,000 to your child, £2,500 to grandchildren, and £1,000 to anyone else. IHT is generally not paid on gifts to charities, The National Trust and political parties.
Setting up a trust
People usually set up trusts to make sure that assets are protected for future generations. This requires complex financial advice, so you must speak with your financial adviser before making any decisions.
Investment in BPR-qualifying companies
Business Property Relief (BPR) can be a valuable relief from IHT, and can be exempt after being held for just two years, provided the shares are still held at the time of death. Our advisers can provide advice on utilising BPR qualifying investments such as: a share portfolio of equities traded on the Alternative Investment Market (AIM) of the London Stock Exchange and also through Enterprise Investment Schemes (EIS).
An IHT-free ISA?
Whilst ISA’s offer valuable tax benefits, they can carry a sting in the tail for your loved ones, as they are not sheltered from IHT. Since 2013 it has been possible to invest in companies listed on the AIM market within an ISA. Provided that the companies qualify for BPR then the ISA can be passed to beneficiaries in accordance with the BPR rules above.
Taking out life assurance to pay for IHT
With a whole of life policy, the benefit is paid out as a lump sum which your beneficiaries can use to pay the IHT due to HMRC.