Passing assets tax-efficiently to the next generation
Making provision for your loved ones after you have gone is an essential part of managing your estate and assets. Death and taxes can’t be avoided, but with careful planning you can pass on your assets to your loved ones so that they can benefit from them in the most tax-efficient way.
Whether you have earned your wealth, inherited it or made shrewd investments, you will want to ensure that as little of it as possible ends up in the hands of the taxman, and that it can be enjoyed by you, your family and your intended beneficiaries.
Securing more of your wealth
There are many things to consider when looking to protect your family and your home. Protecting your estate is ultimately about securing more of your wealth for your loved ones and planning for what will happen after your death to make the lives of your loved ones much easier.
If you don’t make the right financial arrangements, your family could potentially have to foot a hefty Inheritance Tax bill in the event of your premature death. Passing assets tax-efficiently to the next generation remains a primary objective for many who have spent a lifetime accumulating their wealth. Providing funds for family members or a charitable interest is also an important way to see the benefit of your wealth during your lifetime, as well as leaving a legacy.
Distributing your wealth
Without an appropriate estate preservation plan, if you pass away, your family may end up spending a substantial amount of time and money battling over your assets – and no one can really be sure of how you were planning to distribute your wealth.
This means that the process of dividing up your assets could become complicated. Estate planning gives you control over what happens to your assets when you pass away. It is a fundamental part of financial planning, no matter how much wealth you have accumulated.
Developing a clear plan
Not only does an estate plan help to ensure that those who are important to you will be taken care of when you’re no longer around, but it can also help ensure that assets are transferred in an orderly manner, and that Inheritance Tax liabilities are minimised.
The process involves developing a clear plan that details how you would like all of your wealth and property to be distributed after your death. It involves putting documentation in place to ensure that your assets are transferred in line with your wishes.
Inheritance Tax is payable on everything you have of value when you die, including:
Savings and investments
Works of art
Any other properties or land – even if they are overseas
Peace of mind after you’re gone
Making sure that you’ve made plans for after you’re gone will give you peace of mind. It’s not nice to think about, but it means that your loved ones can carry out your wishes and be protected from Inheritance Tax. You don’t have to be wealthy for your estate to be liable for Inheritance Tax when you die.
Any part of your estate that is left to your spouse or registered civil partner will be exempt from Inheritance Tax. The exception is if your spouse or registered civil partner is domiciled outside the UK. The maximum you can then give them before Inheritance Tax may need to be paid is £325,000. Unmarried partners, no matter how long standing, have no automatic rights under the Inheritance Tax rules.
Executors make the necessary decisions
Where your estate is left to someone other than a spouse or registered civil partner (for example, to a non-exempt beneficiary), Inheritance Tax will be payable on the amount that exceeds the nil-rate threshold. The current threshold is £325,000 for tax year 2020/21.
Every individual is entitled to a nil-rate band (that is, every individual is entitled to leave an amount of their estate up to the value of the nil-rate threshold to a non-exempt beneficiary without incurring Inheritance Tax).
If you are a widow or widower and your deceased spouse did not use the whole of his or her nil-rate band, the nil-rate band applicable at your death can be increased by the percentage of nil-rate band unused on the death of your deceased spouse, provided your executors make the necessary elections within two years of your death.
Non-exempt gifts made within seven years
To calculate the total amount of Inheritance Tax payable on your death, gifts made during your lifetime that are not exempt transfers must also be taken into account. Where the total amount of non-exempt gifts made within seven years of death – plus the value of the element of your estate left to non-exempt beneficiaries – exceeds the nil-rate threshold, Inheritance Tax is payable at 40% on the amount exceeding the threshold.
This reduces to 36% if the estate qualifies for a reduced rate as a result of a charity bequest. In some circumstances, Inheritance Tax can also become payable on the lifetime gifts themselves – although gifts made between three and seven years before death could qualify for taper relief, which reduces the amount of Inheritance Tax payable.
Estates worth more than £2 million on death
Since 6 April 2017, an IHT ‘residence nil-rate band’ is available in addition to the standard nil-rate band. It’s currently worth up to £175,000 for tax year 2020/21. It starts to be tapered away if your Inheritance Tax estate is worth more than £2 million on death. Unlike the standard nil-rate band, it’s only available for transfers on death. It’s normally available if you leave a residential property that you’ve occupied as your home outright to direct descendants.
It might also apply if you’ve sold your home or downsized from 8 July 2015 onwards. If spouses or registered civil partners don’t use the residence nil-rate band on first death – even if this was before 6 April 2017 – there are transferability options on second death. As a number of conditions apply, it’s best to review your Will and obtain specialist professional advice if you’re hoping to rely on the residence nil-rate band.
Taper relief applies where Inheritance Tax, or additional Inheritance Tax, becomes payable on your death in respect of gifts made during your lifetime. The relief works on a sliding scale. The relief is given against the amount of tax you’d have to pay rather than the value of the gift itself. The value of the gift is set when it’s given, not at the time of death.
HM Revenue & Customs (HMRC) permits you to make a number of small gifts each year without creating an Inheritance Tax liability. Each person has their own allowance, so the amount can be doubled if each spouse or registered civil partner uses their allowances.
You can also make larger gifts, but these are known as ‘Potentially Exempt Transfers’ (PET), and you could have to pay Inheritance Tax on their value if you die within seven years of making them. Any other gifts made during your lifetime which do not qualify as a PET will immediately be chargeable to Inheritance Tax. These are called ‘Chargeable Lifetime
Transfers’ (CLT), and an example is a gift into a discretionary trust.
The taxation rules of CLTs are complicated, and you should obtain professional advice if you are considering a CLT. Also, if you make a gift to someone but keep an interest in it, it becomes known as a ‘Gift With Reservation’ and will remain in your estate for Inheritance Tax purposes when you die.
HMRC permits you to give the following as exempt transfers:
Up to £3,000 each year as either one or a number of gifts. If you don’t use it all up one year, you can carry the remainder over to the next tax year. A tax year runs from the 6 April one year to 5 April in the next year.
Gifts of up to £250 to any number of other people – but not those who received all or part of the £3,000.
Any amount from income that is given on a regular basis, provided it doesn’t reduce your standard of living. These are known as gifts made as ‘normal expenditure out of income’.
If your child is getting married, you can gift them £5,000; if a grandchild or more distant descendent is getting married, you can gift them £2,500; and a friend or anyone else you know, you can gift them £1,000.
Donations to charity, political parties, universities and certain other bodies recognised by HMRC.
Maintenance payments to spouses (and ex-spouses), elderly or infirm dependant relatives, and children under 18 or in full- time education
There are certain other gifts that can qualify for relief from Inheritance Tax. These can include gifts of a small business, sole trader enterprise, or partnership, and shares in companies listed on the smaller, more risky stock exchange, the Alternative Investment Market (AIM).
Farmers can also gain up to 100% relief from Inheritance Tax when making gifts of certain agricultural land or farm buildings. But the rules in both these situations are complex, and you’d be best to seek expert advice before gifting anything away.
Members of the armed forces killed in action or whose death is hastened by injuries sustained on active duty are also exempt from Inheritance Tax.
Life insurance policy
If you don’t want to give away your assets while you’re still alive, another option is to take out life cover, which can pay out an amount equal to your estimated Inheritance Tax liability on death. Taking out a life insurance policy written under an appropriate trust could be used towards paying any Inheritance Tax liability.
Under normal circumstances, the payout from a life insurance policy will form part of your legal estate, and it may therefore be subject to Inheritance Tax. By writing a life-insurance policy in an appropriate trust, the proceeds from the policy can be paid directly to the beneficiaries rather than to your legal estate, and will therefore not be taken into account when Inheritance Tax is calculated. It also means payment to your beneficiaries will probably be quicker, as the money will not go through probate.