It’s only natural that you wish to leave loved ones in the best financial situation possible. After countless years of hard work and savings, your money should be passed down to friends or family members in the most tax efficient way.
However, with so many tax rules and regulations, it can often be confusing to find the best way to do so.
In this Inheritance Tax planning guide, we’ll cover a range of strategies you can adopt to make the most of tax relief and ensure your estate is handled the way you intended.
What is Inheritance Tax planning?
Inheritance Tax (IHT) planning is a way to prepare for a future in which you are no longer here.
Having a range of Inheritance Tax planning strategies in place could help you pass down assets to loved ones with minimal tax liabilities and maximum financial opportunities.
If you would like to preserve your wealth for future generations, it’s crucial that you understand your IHT planning options.
Simply put, Inheritance Tax is a tax levied on your estate when you pass away, which, ultimately, can reduce the value of your estate once it's passed down to your beneficiaries.
If the entire value of your estate does not surpass the £325,000 threshold, or you choose to leave everything above this figure to a spouse, civil partner, political party, or charity, for example, you are exempt from paying Inheritance Tax.
If you want to learn how to plan for Inheritance Tax, you must first grasp the concept of the nil-rate band.
In effect, the nil-rate band refers to the £325,000 tax allowance each individual has on their estate. If you pass down your estate to a direct descendent, you can benefit from a Residential Nil Rate Band, also known as RNRB.
Inheritance Tax planning for married couples
Married couples can benefit from increased tax benefits.
If you leave your estate to a registered civil partner, your assets won’t be subjected to Inheritance Tax. Furthermore, you can transfer your nil-rate band or residence NRB to your spouse once you pass away, raising the total tax-free threshold to £650,000.
Adopting this estate planning Inheritance Tax strategy could significantly reduce the impact IHT poses on your assets.
Inheritance Tax planning for unmarried couples
As an unmarried couple, you won’t be able to benefit from any unused transferable tax rights, which could result in higher tax charges on your estate.
Inheritance Tax planning for unmarried couples is also more complicated when you own assets together, such as residential property.
If you are joint tenants, meaning you and your partner own the entire property, and your partner inherits your share, they must pay taxes on any amount that surpasses the Inheritance Tax threshold.
Even if you don’t leave a will, your partner could employ the ‘right of survivorship’ which would allow them to claim the rest of the property. However, the relevant Inheritance Tax will still be applied to the assets.
How much IHT will I need to pay?
The amount of Inheritance Tax due varies according to the value of your estate. Any assets valued above the £320,000 for an individual and £650,000 for a couple nil-rate band will be taxed at a standard IHT rate of 40%.
However, if you donate 10% or more of your net value to a charity, the IHT rate is lowered to 36%.
Effective IHT planning
There is a wide range of Inheritance Tax planning options to consider when developing a strategy. We’ll cover some of the most popular Inheritance Tax planning UK methods down below.
Wills and Inheritance Tax planning are two fundamental concepts that go hand in hand.
If you want to ensure your wishes are fulfilled after you are no longer here, you’ll need to appoint a dependable executor and create a Will. To ensure your Will remains as tax efficient as possible, make sure to update it as the years go by.
You can use Gifts Inheritance Tax planning whilst you are still alive to pre-emptively reduce the amount of tax due on your assets.
Lifetime Gifts can be categorised into three groups, which include Exempt Transfers, Potentially Exempt Transfers (PETs) and Chargeable Lifetime Transfers.
Exempt Transfers are Gifts that can be made at any time, without incurring Inheritance Tax. More specifically, you can give up to £3,000 a year as a tax-free Gift.
Between spouses and civil partners, there is no Inheritance Tax to pay on Gifts, regardless of the value.
Similarly, you can make tax-free wedding Gifts, which include up to £5,000 for children, £2,500 for grandchildren, and £1,000 for anyone else. Furthermore, you can make small Gifts of up to £250 per person each year.
Potentially Exempt Transfers (PETs)
Potentially Exempt Transfers (PETs) are any Gifts that surpass the monetary values described above.
Although you don’t have to pay tax on these Gifts right away, the amount of IHT due depends on the Inheritance Tax planning 7 year rule.
If you pass away less than three years after making your Gift, the Gift will be taxed at the full 40% rate.
However, if you die within three to seven years of making a Gift, you will be taxed via a sliding scale known as taper relief.
If you live more than seven years after making your PET, the Gift no longer forms part of your estate and, therefore, no IHT is due.
Chargeable Lifetime Transfers
Finally, Chargeable Lifetime Transfers, or CLTs for short, are Gifts that are made into flexible or discretionary Trusts.
When you make a CLT, you won’t have to pay Inheritance Tax if the total number of CLTs in the past seven years has not exceeded your nil-rate band.
However, if it does, then you will incur an additional lifetime Inheritance Tax charge of 20% on the excess.
Adding Trusts and IHT Planning into your strategy means your assets will no longer form part of your estate when you pass away.
Although IHT Trust planning can increase tax efficiency for your beneficiary, it can also limit your access to funds, so make sure you evaluate your options before going down this route.
Pensions and IHT planning are used to pass down wealth to loved ones in a tax-efficient manner.
If you can afford to give away money from your pension income, without it affecting your lifestyle, you are exempt from paying IHT.
If you die before turning 75, the remaining benefits of your pension can be inherited by beneficiaries as a lump sum, annuity, or drawdown.
Furthermore, the funds in your pension will be IHT-free as long as they are in drawdown. All in all, it’s worth exploring pensions and Inheritance Tax planning as part of your strategy.
Are there any exemptions from IHT?
Individuals who work in high-risk environments, such as armed forces, police, paramedics, firefighters, and humanitarian aid workers, are exempt from paying IHT if they pass away during service.
Similarly, if they sustained injuries during service that eventually lead to their death, they may also be exempt from IHT.
What happens if I inherit my parent’s estate?
When you inherit your family home, you are typically looking at a tax-free threshold of up to £500,000.
However, if the value of the estate exceeds this figure, you will have to pay the standard 40% Inheritance Tax Rate on the excess.
What if my partner died years ago?
Even if your partner died years ago, you would receive the equivalent percentage of their unused allowance.
For example, if your partner passed away a few years ago and only used 25% of their allowance at the time, you would receive an additional 75% of their threshold in current allowance terms. Therefore, you would receive 75% of their £325,000 allowance.
What is BPR in IHT planning?
Business Property Relief, or BPR for short, can also form part of your IHT planning strategy if your estate includes any businesses or business assets. Depending on the type of business assets you own, you can claim IHT relief at 50% or 100%.
What if we were tenants in common?
If an unmarried couple are tenants in common, the living partner who inherits the share of the property would still be subjected to IHT if the value of that share surpasses the nil-rate band.
What do I do if I think HMRC has made a mistake with my IHT?
If you think there has been a mistake, you can make a direct claim to HMRC or seek financial advice from a professional.
Will IHT affect my business?
Ultimately, the amount of IHT due depends on the nature of your business assets, therefore it’s best to seek Inheritance Tax planning advice to see if you qualify for Business Property Relief.
We hope you have found this IHT planning guide useful and that you have a better understanding of how to leave your loved ones the best legacy possible.
There are countless options at your disposal, so make sure to plan ahead to maximise your opportunities for tax efficiency.
If you think you could benefit from some Inheritance Tax planning advice, Efficient Portfolio works with a wealth of professionals and financial advisers who will be able to guide you further on this topic. Contact us today.