Top 4 Ways to Avoid Inheritance Tax
Inheritance tax is a major factor to take into consideration when we’re planning our loved ones’ futures. Leaving a strong, comprehensive, and detailed will behind is key to ensuring that your estate is distributed among your family according to your wishes – and, for that reason, key to giving you the peace of mind that comes from knowing they will be safe and secure when you are no longer there to provide for them.
But inheritance tax rates are high, and they can take a significant portion of your estate out of what your loved ones are planning to receive. Inheritance tax, or IHT, applies to any value exceeding the £325,000 threshold (nil rate band) and generally falls around the 40% mark, which means a large portion of the population will find that their estate is subject to significant tax. House prices are rising, and, for many areas of England (like the Southwest and London) the average house price far exceeds this threshold. *
In Bristol, for instance, Zoopla found that the average house price for a semi-detached property between 2021 and 2022 is just over £376,000. * With home values far exceeding the threshold, it is daunting to consider the full scope of your estate’s eligibility for IHT. As a financial advisor based in Bristol, we have first-hand experience of the potentially devastating impact of these tax laws on families – and how to reduce that impact.
Can you avoid inheritance tax altogether?
No – and this is the most important thing to keep in mind. Unless the total value of your estate falls below the £325,000 threshold, you cannot avoid inheritance tax altogether. There are ways of reducing its impact on your estate, but not of making it ‘immune’ to taxation. You may be able to benefit from the residential nil rate band which adds an additional £175,000 to the standard nil rate band. However, It is worthwhile checking if you meet the criteria for the RNRB and whether you are eligible to claim it.
The good news is, there are some easy things you can do now, here are the top 5 ways of lessening the impact of IHT on your families’ inheritance.
Gift assets to loved ones sooner rather than later
Any assets given away to friends or family seven or more years before you die are outside the scope of inheritance tax. If you’re too late in making these gifts, however, then they may be subject to tax.
Does that mean anything you give away will be subject to IHT if you die within seven years? No – not exactly. How much you gift and when will determine whether there could be any tax due on gifts made during your lifetime. The rules around gifting are complex and it’s important to take advice to make sure you structure your gifts in such a way that limits any tax due.
You are allowed to ‘gift’ up to £3,000 a year to loved ones without it being subject to IHT if you do die within those seven years, and to gift up to £5,000 on your child’s wedding day (or £2,500 for a grandchild or great grandchild, or £1,000 for someone who falls outside of those categories).
You can also give away unlimited gifts of £250 or less, if the recipient is not going to receive one of the gifts mentioned above within that same tax year.
It can be complicated keeping on top of these gifts, but doing so will pay off for you, since it will enable you to give as much away as possible while you’re still here, and alleviate any worries about repercussions years down the line.
Leave some of your estate to charity
The value of any charitable donations stipulated within your will won’t be subject to inheritance tax and will be taken off the total value of your estate. So, if the total value of your estate is £360,000, and you make £30,000 in charitable donations, only £5,000 will be subject to IHT (assuming you don’t qualify for the residential nil rate band). Likewise, any gifts made to charity during your lifetime won’t be subject to the seven year rule.
The alternative is making charitable donations with a view to reducing your inheritance tax rate. If you leave 10% or more of your estate to charity, you can reduce that rate (which, for the majority of people, will mean a rate below 40%).
Obviously, there is no one-size-fits-all solution for distributing your estate between your loved ones and charities, so you’ll want to talk this through as you draft your will.
Put money into trusts
In some cases, it is possible to reduce the total value of your estate (and, as a result, reduce the amount of money subject to inheritance tax) by moving funds into trusts for your children or grandchildren. There are very specific restrictions to work around, but it can prove to be an effective way of passing money onto the next generation without worrying about the impact of IHT.
The great thing about trusts is that they can allocate funds for a specific purpose (like education) and remain inaccessible until the beneficiary reaches a certain age, so you needn’t hold-off creating those trusts if the beneficiary is still too young to handle that amount of money responsibly.
There are some complexities to take account of when putting money into trust so it’s important to take advice from professionals to ensure you don’t fall foul of any of the rules.
Life insurance ‘in trust’
Life insurance pay-outs can contribute to the total value of your estate subject to inheritance tax unless that insurance policy is placed in a trust. If you do this, you can consider the value of your policy to lie outside of the scope of your estate, and, as a result, not liable for tax.
This can be particularly valuable if you are cohabiting with your partner, but not married. Since unmarried couples do not have the same rights as married couples, it is incredibly important that you are confident you know how your policy will benefit your partner (and how much), as well as ensuring your will clearly names them. The laws of intestacy (which come into play when wills are invalid, or when a will hasn’t been written) do not consider unmarried partners to be potential beneficiaries, so making sure everything is watertight is incredibly important.
If you’re looking to put your policy into a trust, then there are a number of different options such as Discretionary and Absolute Trusts. What you choose will depend on your situation, and your plans for your loved ones’ futures.
Please note: The FCA do not regulate will writing, tax planning and trusts.