We all know how important it is to plan for the future. Despite all the unknowns that define the next few years and decades, there is a surprising amount that we can work to get under control. True, we can never know exactly what the future holds, but we can work to put together a strong, watertight plan that protects our loved ones from risk and unnecessary hardship, and ensures that our estate is distributed according to our wishes.
Of course, some factors will always lie outside of our control. For so many people whose estates qualify for inheritance tax (IHT) – a steep levy imposed on any value exceeding the threshold (nil rate band) which, as of 2022, sits at £325,000 – circumventing those charges entirely is very difficult.
That is, perhaps, the first thing any ‘newcomer’ needs to get their head around: that inheritance tax planning is there to minimise the impact of IHT, rather than dodging it altogether. This is what inheritance tax planning is – it’s taking advantage of the ways in which you can shield significant portions of our estate from tax, and ensure your beneficiaries get as much as possible.
With that in mind, here are the very basics that anyone new to the idea of inheritance tax planning needs to know.
1. The sooner you start, the better
Just as you can never be too early to plan for your pension and retirement, it’s never ‘too soon’ to start thinking about ways to ensure your family has the protection offered by a strong plan to minimise IHT.
Why? Because, while some things – like setting up trusts for certain family members – can be achieved in a relatively short span of time, other options for reducing the taxable portion of your estate need to be seen to well in advance of your death, or they may prove useless. And, in a broader sense, protecting your finances is a lifelong responsibility – one that you hold to yourself, and to your family.
For instance, money and assets given away as gifts seven or more years prior to your death are not subject to inheritance tax. There are some restrictions – for instance, if you gave your home to your child and continued to live in it rent-free, this would not be considered a gift.
Within seven years of your death, you can still gift money free of inheritance tax to loved ones, but there are limits on how much, who, and how many people can receive these gifts during each tax year. This ‘allowance’ is typically referred to as a person’s annual exemption – although plenty of people don’t even realise that they’re entitled to this exemption.
This is why it is important to work out the best plan for action for gifting assets with an experienced financial advisor. If not, your efforts may be wasted, and the truth may not come to light until after you have died.
2. You’re entitled to an extra allowance if you’re passing on the family home
It is common practice for homeowners to allow ownership of the family home to pass onto their children or grandchildren, and doing so will offer a healthy boost to your nil rate band (the threshold that determines how much of your estate is taxable).
As of 2022, leaving your home to your children, grandchildren or great grandchildren will raise your nil rate band by £175,000. So, if your estate is valued at £800,000, £300,000 will be subject to inheritance tax. The other £500,000 will be untaxed.
This can be a big help, but it still means a steep charge on your estate. The current standard rate of IHT is 40%, which means that, of that £300,000, £120,000 will still be sacrificed to inheritance tax (and, as a result, deducted from your loved ones’ inheritances).
It is important to keep in mind that this allowance is only available on the main family home. You won’t get the same boost to your nil rate band from any other properties you own – whether investment properties or holiday homes.
That is, unless you do more to plan against inheritance tax in the years before your death.
3. Leaving everything to your spouse or civil partner can mean you are exempt from inheritance tax
If you bequeath your entire estate to your spouse, then, typically, your spouse won’t need to pay inheritance tax, even if the total value of the estate exceeds the nil rate band. It is very important to remember that your spouse won’t necessarily inherit the entirety of your estate. Above a certain threshold, any children (biological or adopted) that you have will be entitled to a portion of your estate. So, if you want to avoid inheritance tax completely, you will have to stipulate that your spouse is the sole beneficiary within your will.
Of course, leaving everything to a spouse isn’t always in the testator’s wishes. Many of us want to leave some sort of inheritance to our children, even if our spouse remains the ‘main’ beneficiary. If so, you will need to take a more calculated approach to reducing the impact of IHT on your estate.
It is also worth keeping in mind that your tax-free allowance will also be inherited by your spouse, meaning that any unused ‘allowance’ will be added to your spouse’s allowance. So, if the entirety of your nil rate band is unused, your spouse’s nil rate band will be £1,000,000.
Getting everything straight in your head (and written down on paper, so that your loved ones understand how to handle things after your death) is incredibly complicated for most people. It’s an ongoing process, and one that, ideally, will be guided by someone who knows the subject inside and out. Otherwise, it is all too easy for you to miss something important.
Perhaps the most important thing any newcomer to IHT planning should know, then, is that working with an independent advisor is paramount. Otherwise, you can’t get that peace of mind you’re looking for – and neither can your loved ones.
Please note: Tax planning is not regulated by the Financial Conduct Authority