Many charities hope to benefit from Make a Will Week or Free Wills Month in October, where you can make a will with a solicitor in exchange for a donation to a charity of your choice. It’s a great reminder to get a will sorted and boost charity funds at the same time. Worryingly, it’s thought that half of UK adults don’t have a will in place and this can cause all manner of problems for loved ones when you die.
Understanding and planning what will happen to your estate (your money, property and possessions) when you die can save your beneficiaries thousands of pounds of Inheritance Tax (IHT). Here is a basic guide on reducing your IHT bill.
What is IHT?
When you die, a probate value is calculated for the total of your assets after your funeral costs and debts have been paid. IHT is charged at 40% on this figure but there are allowances and exemptions that reduce the amount to be taxed. IHT is taken from the estate funds or directly from the deceased’s bank account or from the sale of assets, it must be paid within 6 months of the person’s death.
What are IHT allowances?
The main allowances to look for are Nil Rate Band (NRB) and Residence Nil Rate Band (RNRB). The NRB is £325k and IHT is only payable on the part of an estate over this amount. It is also possible to inherit a spouse’s NRB where their assets are left to the surviving spouse, giving a NRB of up to £650k.
The RNRB is an extra allowance which is available to assist in passing the family home down the generations. It is available on estates worth less than £2m when the home is passed to children or grandchildren (including adopted/fostered children). In the tax year 2019/20, the RNRB allowance is worth £150k per individual, from April 2020 it increases to £175k and from 2021 it will increase by an inflationary rate. Like the NRB, the RNRB can be transferred to a surviving spouse to be doubled up on the second spouse’s death.
What about lifetime gifts?
Lifetime gifts that are made absolutely (i.e. directly to an individual rather than into a trust) are free of IHT at the time of the gift but remain chargeable within the donor’s estate for 7 years. These are called Potentially Exempt Transfers (PETs). Some transfers are immediately exempt but otherwise, the value of the gift remains in the estate for 7 years, with the rate of tax reducing like this:
- 0-3 yrs: 40% tax
- 3-4 yrs: 32% tax
- 4-5 yrs: 24% tax
- 5-6 yrs: 16% tax
- 6-7 yrs 8% tax
- 7 yrs: nil
Don’t forget that although outright gifts might be advantageous from an IHT perspective, they will be liable for Capital Gains Tax (CGT) at disposal. It’s worth finding out what the long-term benefits of different paths would be.
Are any assets taxed differently?
The value of a trading business is generally exempt from IHT due to the applicability of Business Property Relief (BPR). There are exclusions for non-trading assets held, such as excess cash, investments and non-trade property. However, this is a valuable relief for many business owners, for whom the value of their business represents a considerable proportion of their wealth and is often referred to as “my pension fund”. However, after a sale, the swap of an exempt asset for cash will result in a significant increase in exposure to IHT. Often on these occasions, people consider moving proceeds into a pension fund (which is outside the scope of Inheritance Tax) or into assets such as AIM or EIS fund investments which also qualify for BPR. It goes without saying that proper financial advice should be taken before making any investment decision.
As noted above, in most cases, assets held within a pension fund are also outside of the scope of Inheritance Tax. With the advent of flexible drawdown, this has led people to think twice before drawing the 25% tax-free cash if they do not have an immediate requirement for the funds. The fact that undrawn pension pots may now be passed on to beneficiaries free of IHT, and also in some cases able to be drawn by them free of income tax means that where finances permit, leaving funds in a pension scheme, invested in suitable funds (again, please make sure you take appropriate financial advice) is often a very tax-efficient option.
What should I do now?
If you take action early enough, it is entirely possible to significantly reduce your CGT and IHT liabilities. The first step is to make sure you have a will in place. Then speak to the tax experts at CRM about the value of your estate with enough time to take action – it is never too soon to plan your tax mitigation. HMRC recognises that forward planning in line with tax legislation is prudent rather than last-minute adjustments that can be viewed as avoidance rather than mitigation.
If you would like to discuss your estate and how you could mitigate your tax liability, please call the friendly tax experts at CRM on 01865 379272.