Inheritance Tax planning can be overwhelming; how do you ensure your family or friends benefit fully from it? Fortunately, protecting your loved ones and assets is easier than you might think.
What is UK Inheritance Tax?
Inheritance Tax is a tax on your estate based on its value, payable after your death.
Currently, this is charged at a rate of 40% on applicable estates. However, there is a reduced rate of 36% for those who leave at least 10% of their estate to a registered charity.
The cost is often covered by your estate or by the administrator of your estate, however, in some circumstances, your beneficiaries may be required to make a payment.
Without adequate planning, it is possible that HMRC could benefit more from your estate than those you intended to leave your possessions to. You can see how much Inheritance Tax you may owe by trying out our online Inheritance Tax calculator.
However, there are many ways to comply with Inheritance Tax UK laws whilst also giving yourself more control over where your assets go after you die, ensuring that you leave behind as much as possible to those you love.
1. You might be able to give assets away now
As the amount of Inheritance Tax you pay is calculated based on the value of your estate, one way to reduce the tax is to reduce the value of your estate.
The number to remember is £325,000. This is the nil rate band decided by the government, anything above this amount is subject to Inheritance Tax whilst anything below is not. Therefore, if you are able to reduce the value of your estate below this number, you can remove the tax altogether.
However, this threshold increases to £500,000 if you have a home which you intend to leave to any children, including step-children, adopted and foster children.
Although it may not be possible to reduce your estate to the nil band, you may still be able to slash the amount due by lowering the value of your estate enough that it falls into a lower tax bracket.
For example, if your estate is worth £700,000 and you’re able to reduce it to £600,000, the Inheritance tax could fall from £100,000 to £60,000, saving £40,000 which can go directly to your chosen beneficiaries.
By giving away assets as gifts now, you can work towards lowering your Inheritance Tax.
Gifts fall into two main tax categories; tax-free now and tax-free later.
Those that are tax-free now are a little simpler. There are no restrictions on gifts under £250, so you can make gifts of this size however often you’d like. Larger gifts can reach a cumulative total of under £3,000 per year without incurring tax. Donations to charity can be even larger and are always considered tax-free gifts.
For those gifts that become tax-free later, the rules are slightly more complex. When dealing with Inheritance Tax, UK law has what is known as the ‘seven-year rule.’ Gifts outside of the tax-free exemptions will, in most cases, no longer be considered part of your estate after seven years.
This means that, if you live for seven years after giving a gift, the value of the gift will be fully deducted from your estate and will not be subject to tax. As a result, it’s a good idea to start Inheritance Tax planning as soon as practical.
If you die before the seven-year marker, you may still receive a reduction in the amount of Inheritance Tax due.
A gift that has been made recently (less than three years before the death) will be fully incorporated back into the value of your estate. However, for each additional two-year period that has passed, there will be a 20% reduction in the value that is added, up to 100% in the seventh year. This is known as ‘taper relief.’
For example, if you were to make a gift worth £5,000 and died between three and four years afterwards, you would receive a discount of 20%. With this discount, £1,000 is deducted from the value of the gift, giving a total of £4000 that will be added back to the value of your estate. In this case, giving the gift has resulted in an overall estate value reduction of £1,000.
2. UK Inheritance Tax planning and life insurance
A strong life insurance policy can protect your estate after your death and ensure that your beneficiaries receive the full amount you expect them to.
By choosing an insurance policy that will pay out the full value of your estate to those you choose, you can protect your interests and avoid unforeseen Inheritance Tax reducing what you leave to those you care for.
Payments that you make into a life insurance policy will likely fall into a tax-free exemption as a gift if you are the one making the payments for your own policy. If someone else is making the payments on your behalf, this may not be the case.
It’s important to remember that a life insurance policy should be written into trust to make sure that Inheritance Tax will not be applied to the payout, seek out advice from a reliable insurer for assistance with this.
For those with weak health or who are older, the premiums can be very expensive and this may limit or prohibit you from accessing the best insurance plans. For this reason, it is advised that you begin Inheritance Tax planning early if possible.
3. Keep clear and accurate records when planning for UK inheritance tax
Organising one’s affairs is a complex task, by keeping clear records you can make the process easier for whoever is in charge of your estate.
Particularly if you have chosen to gift some of your assets to reduce the size of your estate, it could be difficult to ascertain what is part of the estate and what isn’t. You can help with this process by keeping well-organised records of what you have kept or given away so the process of valuing your estate runs smoothly.
If you plan effectively and maintain your records, you can maximise the value of your estate and make sure that your beneficiaries receive as much as possible.
In some cases, it can be difficult to decide whether something was given as a gift or if it should be counted as part of the estate. In this situation, your records may be valuable in determining the outcome.
Some assets may be considered part of your estate even if you have intended to gift them away, however. If you are still benefitting from an asset, it may not be considered a gift and could be included as part of your estate.
For example, if you gift somebody a boat but continue to be the primary user of it, the value of that asset may still be included in your estate as you continued to benefit from it.
In order to ensure the best possible outcome, you should maintain good records and be mindful of any potential issues that may arise. By getting ahead of your Inheritance Tax Planning and leaving your affairs well-documented, you are more likely to achieve a favourable outcome after your death.
4. UK Inheritance Tax trusts can be tricky
It is very common for people to gift their assets to a trust so that Inheritance Tax won’t be applied to them. However, this can raise other issues as other taxes may be applied to the value of the assets given.
There may be a 20% tax on your initial gift and subsequent yearly taxes of 6% every decade. The tax laws surrounding trusts are nuanced and you should always ensure that you understand the structure of any trust before you commit to it.
It should also be noted that your beneficiaries may need to pay Inheritance Tax on an estate held by a trust if the trust is unable to pay. Beneficiaries may also face Capital Gains Tax if they later decide to sell any part of their inheritance, such as a property.
When in a trust, your assets will be controlled by a trustee (or a group of trustees) who will manage your estate on your behalf for your beneficiaries.
As a result, you should always be careful when deciding if your assets are best left with a trust and speak with qualified professionals for advice.
Care for your Affairs
Managing your affairs can be difficult and may seem overwhelming. However, with some simple steps, you can take control of your assets and make sure that you leave those you love with the best possible outcome.
It’s important that you gain insight into your finances to make the most out of your estate. No matter what you decide to with your estate, these factors could potentially have a huge impact on your final Inheritance Tax bill.
Move forward with clarity and confidence by contacting us here at Tax Expert for the expert advice you can trust.
To get started, book an appointment with us today by calling us at 01772 788200 or send us an enquiry by e-mail by leaving your contact details below along with your question.
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