Inheritance tax used to be something only the wealthy worried about, but following years of rising house prices, many property-owning middle-class families are grappling with how inheritance tax will affect them.
Savvy financial planning could save your family thousands in inheritance tax on your estate when you die. There are in fact perfectly legitimate ways to avoid inheritance tax.
So, what is inheritance tax and what can you do to minimise the tax bill to your loved ones when you pass away?
What is Inheritance tax?
When you die, your assets above a threshold of £325,000 will be subject to inheritance tax (IHT) at a rate of 40 per cent. The assets liable include cash, investments, property, vehicles and life insurance payouts.
There is an additional exemption for the family home, known as the ‘family home allowance’, which applies to a family home going to direct descendants only.
In 2019/20 the family home allowance is worth an additional £150,000 in inheritance tax exemptions, rising to £175,000 in 2020/21. Married couples can combine their IHT thresholds, so the first £650,000 of their combined estate is exempt from IHT.
Whatever you decide to do in terms of inheritance tax planning, it’s important that you make a will.
Married couples and civil partners are allowed to pass their whole estate to their spouse tax-free when they die. However, gifts to an unmarried partner might still incur inheritance tax.
Gift assets to family and friends
You can make an annual tax-free gift of £3,000 to other family members, friends or anyone else you choose. In addition, you can make wedding gifts to your children or grandchildren, which are also exempt from tax.
You are free to make larger gifts, but if you die within seven years of making the gift, inheritance tax may still apply under the seven-year rule which tapers the percentage IHT due according to how many years prior to your death the gift was given.
Gift assets to a charity
if you had to choose between giving money to a charity or the taxman which would you prefer? Not many people realise that this is actually a choice they are making.
Did you know that gifting to a charity in your will could significantly reduce your inheritance tax liability? What’s more, if you leave a minimum of 10 per cent of your estate to charity the inheritance tax rate for the remainder of your taxable estate drops to 36 per cent instead of 40 per cent. Do the maths. This could be an option for you.
If you do decide to leave money to a charity in your will, it is a good idea to discuss this with your family so that it doesn’t come as a shock when you die. As parents are now living for longer, some are choosing to leave money to charity as their children have already built up their own assets, but this, along with more complex family situations, is causing a rise in inheritance disputes.
Set up a trust
Putting money or property into a trust is one way you may be able to reduce your inheritance tax bill when you die. So, what is a trust? A trust is a legal arrangement where you give money or assets to someone else to look after for the benefit of another person.
Trusts are most commonly used to put money aside for children. Provided certain conditions are met, when you die, the value of the trust won’t normally be included in your inheritance tax calculations. There are several types of trusts.
To understand which type of trust is best for your personal situation it is best to speak with your solicitor or IFA (Independent Financial Adviser). For more information on using a trust to cut your inheritance tax see here.
Take out life insurance
Life insurance policy payouts to provide a one-off payment or regular income to your dependents when you die aren’t usually subject to income tax or capital gains tax, but they are subject to inheritance tax at 40 per cent. However, if you set up the policy within a trust the proceeds won’t be taxed as part of your estate. Read more about life insurance policies and inheritance tax here.
Why spend your later years on a budget? You’ve worked hard all of your life, so why not enjoy the fruits of your labour. One of the easiest ways to avoid inheritance tax is to spend your money during your lifetime! It’s worth serious consideration since your beneficiaries will be taxed 40 per cent on many of your assets anyway. Retirement is the perfect time to travel the world and see the sights you’ve always dreamed of visiting.