What is inheritance tax?

Inheritance tax is the tax paid on assets (after inheritance tax allowances are deducted) left when someone dies. As Benjamin Franklin is quoted as saying, the only things certain in life are death and taxes, and inheritance tax (IHT) touches on both.

How does inheritance tax work?

When you die, the Government assesses how much your estate is worth, then deducts your debts from this to give the value of your estate. Your assets include:

  • Cash in the bank
  • Investments
  • Any property or business you own
  • Vehicles
  • Payouts from life insurance policies

Your estate will owe tax at 40% on anything above the £325,000 inheritance tax threshold when you die (or 36% if you leave at least 10% to a charity) – excluding the ‘main residence’ allowance (see below).

When do you pay inheritance tax?

The executor of your will should pay any IHT owing from your estate within six months of your death. After this time, HMRC can begin charging interest on the outstanding amount. If there is no will, the administrator of the estate will pay the bill. If there is not enough cash in the estate, assets can be sold to raise funds. Once the tax and any other debts or liabilities are paid, the remaining assets can be distributed to your beneficiaries.

Exemptions from inheritance tax

People in certain ‘risky’ roles are exempt from paying inheritance tax if they die in active service. Included in this are armed forces personnel, police, firefighters and paramedics, plus humanitarian aid workers. The exemption also comes into play if a person who was injured on active service has their death hastened by the injury, even if they’re no longer on active service.

If you think your estate might have to pay Inheritance Tax, here are 7 simple things you can do to reduce the taxman’s cut – and not all of them involve changing your will.

  1. Leave your estate to your spouse

The easiest way to eliminate IHT is to leave your estate to your spouse or civil partner. Your spouse or civil partner will never have to pay tax on assets you leave them, regardless of the amount. Making the most of this in your will can save your family a small fortune.

  1. Use property allowances

If you’re leaving your estate to children or grandchildren, the new property allowance let you leave more of your home before tax is due. In the current 2019-20 tax year, it’s worth £150,000 per person, rising to £175,000 in April 2020.

  1. Give to family members or friends

Each tax year, you’re allowed to give up to £3,000 away as a gift, split between however many people you like. You’re also allowed to make unlimited gifts of up to £250 to others, too.  If you’re off to a wedding, you can give up to £1,000 and never have to worry about inheritance tax. You can give up to £2,500 to grandchildren, and £5,000 to your children too. Wedding gifts must be made before the wedding, and the wedding must go ahead, otherwise they’ll be classed as potentially exempt transfers.  If you make gifts above the thresholds, they may be taxable if you don’t survive for seven years after making them. Otherwise they’ll be tax-free too.

  1. Leave money to a charity.

Any money you leave to a charity, providing it is registered in the UK, will always be free from inheritance tax. The same goes to gifts to political parties, or to local sports clubs.  What’s more, if you leave more than 10% of your taxable estate to one of these groups in your will, the inheritance tax rate for the rest of your estate will fall from 40% to 36%.

  1. Make use of pensions

Pensions are one of the most tax-efficient ways to pass on your wealth. If you pass away before the age of 75, benefits left in a money purchase pension can be paid as a lump sum or drawdown income to any beneficiary, with absolutely no tax to pay. After the age of 75 they will be taxed at the beneficiaries’ marginal income tax rate. It might make sense to use other investments, such as individual savings accounts, to provide a retirement income and retain funds in your pension for as long as possible. As long as the funds remain in drawdown, they will remain IHT free. This means you can pass your pension on to your children, and then they can pass it on to their children who in turn can pass it to their offspring, raising the prospect of pension money cascading down the generations.

  1. Take control with trusts

Trusts can reduce an IHT bill and give you control over how your assets are used by future generations.

Trusts can help you:

  • Keep a lump sum outside of your survivor’s estate to ensure it is not subject to IHT
  • Protect your children/grandchildren’s legacy if your surviving spouse remarries
  • Protect your children/grandchildren’s legacy from their own marital disputes
  • Avoid giving children/grandchildren a sum of money that they may not spend as wisely as you would like.

Trusts can be a complex matter. For example, if you die within seven years of making a transfer into a trust your estate will have to pay IHT at the full amount of 40%.

  1. Don’t forget life assurance

If you take out a life insurance policy, it won’t reduce the amount of Inheritance Tax due on your estate. But the payout might make it easier for your surviving family to pay the bill. It could mean that they are able to prevent the family home from being sold. But if you do this, make sure the life insurance payout goes into trust – if you don’t it will make your estate bigger and it will have to pay more tax.

Estate planning is a complex area that is subject to regular regulatory change. If you have a very large and complicated estate, the sooner you start planning the better. For many people, though, an opportune time to establish an IHT plan is soon after retirement. At Outsourced ACC we encourage and guide our clients to plan for IHT well in advance.  Give us a ring today if you would like to speak to one of our experts.

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