Inheritance tax planning advice guide
First published 24 October 2017 • Updated 10 October 2019
You can’t live forever – but you can help your loved ones inherit as much of your wealth as possible. If your total assets are over the inheritance tax (IHT) threshold, your family may have to pay a bill soon after your death. But with advance inheritance tax planning and advice you can keep that bill to a minimum.
What is inheritance tax?
Inheritance tax (IHT) is the tax your beneficiaries may have to pay if your estate (that is, everything you own) is above a certain size. You can leave up to £325,000 to your beneficiaries tax-free – this is known as the IHT nil-rate band. Everything about that threshold will be taxed, usually at the rate of 40 per cent. For large estates, this can result in a very substantial bill.
Who pays inheritance tax?
If you have a will, the named executor will be responsible for arranging the tax payment to HMRC. If you don’t have a will, the administrator of your estate will do this instead.
The tax payment is usually made from the funds within the estate (or from money raised by selling assets within the estate). After inheritance tax has been paid, the remaining value of the estate is distributed.
A common challenge is that HMRC requires IHT to be paid within six months, but probate (the process of releasing assets from an estate) often takes longer than that. Also, probate isn’t usually granted until IHT has been paid, which can seem like a catch-22. However, there are a number of possible solutions.
Solution 1: If there's enough cash in the estate to settle the IHT bill, the executor can arrange a payment directly from the estate to HMRC.
Solution 2: If there isn't enough cash in the estate, the executor can secure a loan from a bank to pay the IHT bill, and repay the sum when probate is granted.
Solution 3: If some of the estate is in the form of property, IHT on the property can be paid off in instalments, over as long as ten years.
There are various other circumstances in which it may be difficult to settle the IHT bill up front. Talk to a financial adviser if you are the executor of an estate and find yourself in this kind of situation.
What about my family home?
There’s now an extra IHT allowance, called the main residence nil-rate band. Set at £100,000 in April 2017, this tops up your £325,000 if you pass a ‘primary residence’ (i.e. your main or only home) on to your children or grandchildren. By 2020 it will be £175,000, meaning a couple could leave up to £1,000,000 of assets tax-free to their children if this includes the family home.
How do I go about inheritance tax planning?
If you leave your entire estate to your spouse or civil partner, they won’t have to pay inheritance tax. There are also exempt beneficiaries, such as charities, who won’t be taxed on anything you leave to them.
There are various ways you can reduce the size of your taxable estate during your lifetime, such as by making gifts, setting up trusts, charitable giving and other forms of planning.
Any gift you give seven or more years before your death is exempt from IHT. However, you must be able to demonstrate that they are outright gifts – if you were to continue receiving rent from a second property, for instance, then it would be called a ‘gift with reservation of benefit’ and so would still be included as part of your estate, even after seven years. The same would apply if you ‘gave away’ your home but continued to live in it rent-free.
With smaller gifts you don’t have to worry about the seven-year rule. You can make up to £3,000 worth of gifts in any tax year, free of IHT. This allowance carries over to the next year, so if you haven’t used the past year’s allowance then a married couple could give away up to £12,000.
Other exemptions apply to wedding gifts – parents can give £5,000, grandparents £2,500 and anyone else can gift up to £1,000. Lastly, any gifts worth £250 or under made to any individual are exempt.
By planning with the help of an adviser, you can use these allowance to steadily reduce the size of your estate, and so reduce the taxable amount.
A trust allows you to set money aside to support a beneficiary in a certain way or at a certain time (such as to pay university fees). Trusts can be placed outside your estate, meaning they can be free of inheritance tax.
You can also set up a life insurance policy specifically to cover the IHT bill. If the policy pays into a trust that is outside your estate, the pay-out itself will not be taxed and can be used to pay HMRC.
Trusts are a specialist area, so be sure to consult a financial adviser first, and a solicitor when setting them up. Find out more about trusts and estate planning.
The golden rule: make a will!
The most important step in inheritance planning is making your will and keeping it up to date. You also need to appoint a dependable executor, as this is the person responsible for ensuring the IHT bill is paid out of your estate. Your solicitor can help you make your will.
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