Inheritance tax: what you need to know
Before seeking professional advice, there are some useful stages and principles to follow if you’re looking to reduce inheritance tax. Duncan Ellis gives us some crucial advice.
If you’re reading this article, I will assume that you are affected by inheritance tax (IHT) and want to do something about it. I have come across many moderately wealthy people in their senior years who are not concerned enough about inheritance tax planning to take steps to reduce it or mitigate it. That’s entirely up to them of course, as one’s level of motivation to pay less tax is a personal issue and we all have differing views on paying tax.
So, assuming your estate is both liable to inheritance tax and you want to do something about planning for it, what can be done?
Stage one: how much is your estate worth?
For a single person who has estate valued below £325,000, there’s no inheritance tax to pay. Over this amount and you’d have to pay 40 per cent of the extra value only. For example, if your estate is valued at £425,000, then £40,000 would be due in inheritance tax, because the 40 per cent rate is only charged on the extra £100,000. If you’re in a marriage or civil partnership you can double this amount to £650,000. These are the nil rate bands (NRB), which we are all individually entitled to on our deaths, meaning the amount we can leave to our heirs without any IHT being applicable.
Stage two: do you own a business?
Don’t include asset value in business assets in this valuation and if you’re unsure, seek advice. But a common trap of planning is that business owners have a high value in their business which isn’t liable to inheritance tax (as there is an exemption for business assets), but once this business asset is sold or crystallised at, or before, retirement, then the exemption will almost certainly disappear, so business owners should start planning sooner rather than later.
Stage three: have you written a will?
What does it say? Where is it? Most people know that leaving everything in their will to their spouse or civil partner on first death means no inheritance tax is due, but what do the wills say on second death or if you both die in the same accident? For example, if you’re leaving wealth from your estate over the nil rate band(s) to charity, then there might not be any inheritance tax due. Also, where is the will? Make sure that your loved ones know where they can find your will.
Assuming the estate are over the allowance and you want to leave your estate to your younger heirs, then before any planning can begin, there are a few simple principles which should be followed.
- Principle one: hold off giving away your capital
Ensure you have sufficient capital for you and your partner for the rest of your lives. In other words, don’t give any capital away (in order to reduce the value of your estate) before you firmly believe you have access to sufficient capital for whatever eventuality might befall you in the future. The most obvious of these potential unknown costs would be the costs of long-term care. How you might pay for this will probably depend on what income you have and where it comes from.
- Principle two: make sure you have an income for the rest of your lives
Ensure you have sufficient income for you and your partner for the rest of your lives. If you have guaranteed income from pensions of over £50,000 with some kind of inflation proofing, then not only are you in a very fortunate position, but it’s likely that you’ll be able to pay for most care home costs out of income, which will free up your capability to plan with capital.
If your income is investment and/or rental income from capital and/or property, then it’s less likely that you can plan to reduce your estate value by removing capital wealth from your estate.
Once you’ve got sufficient capital and income for your needs for life, THEN you can start to look at some simple planning.
- Principle three: spend your ISA
A little-mentioned idea is to plan on spending your ISAs. We all try to build these “tax free” savings pots throughout our lives and are reluctant in retirement to spend them, apart from the natural tax free income “yield”. This only means that when we die, these “tax free” savings get taxed for IHT. So don’t plan to leave tens or hundreds of thousands in ISAs, but rather spend more from this capital than you might with other capital wealth. This idea clearly always subject to one’s personal circumstances.
Finally, you’re left with three basic methods of planning:
1. Give capital wealth away – either directly to the intended beneficiary or by the use of Trusts. There are many products on the market achieving this if you don’t want to gift directly and I would obviously recommend seeking advice from a good independent financial adviser.
2. Rearrange your wealth using methods or products which mean you reduce the inheritance tax liability but retain control and ownership of the assets in question. Again, seek advice from a suitably qualified adviser.
3. Plan now to pay it in the future. This essentially entails starting a whole-of-life insurance plan, which means you’re saving for the likely inheritance tax liability throughout your lifetime with your own money (and/ or using money from your heirs) and there’s life cover in there if you die younger than expected.
Sometimes, wealthy people might consider this strategy throughout their working lifetime (in their 50s or 60s for example) in case some terrible accident or illness befalls them, but with the view that in their retirement and once they’ve secured their financial wellbeing, they’ll take other steps to mitigate inheritance tax using the methods mentioned above. For instance it’s normally very cheap to insure an IHT liability for ten years or less with insurance policies which are never intended to last longer than ten years.
So, if you’re wealthy enough to have an estate liable to inheritance tax AND you want to reduce it AND you’ve got sufficient capital and income for your own needs, you can quite easily plan for IHT.
But, seek advice on all the potential methods and then get personalised advice on choosing the right planning strategy which suits your circumstances.
Are you paying more tax than you need to? Use our handy Tax Waste Calculator to find out where you could save.
About the author
Duncan Ellis is the Director of Lighthouse (Capital) Limited, based in Kent near Tunbridge Wells, with an office in London. He has been an independent financial adviser since 2001 when he set up Lighthouse (Capital) Limited with two other directors.