Many families stand to lose more money to the Government through Inheritance Tax (IHT) than they really should. In 2016, £585 million was spent unnecessarily on IHT by British taxpayers. With IHT receipts expected to reach an all-time high in 2018, it seems unlikely that this trend will reverse in 2019.
Certainly, everyone should pay their fair share to society, but why should your loved ones lose out needlessly? At MGFP we can help you to put sensible measures in place ahead of time to ensure that you, one day, leave a meaningful legacy to your family.
Here are some practical ways we can help you to reduce your IHT liability:
A new rule was introduced on 6 April 2017 which has had an important impact on IHT planning. It is something to consider if you have direct descendants.
To quickly recap, in 2019-20 Inheritance Tax (IHT) is levied at 40% on the value of your Estate over £325,000. This threshold is called the Nil Rate Band (NRB).
Your “Estate” includes assets such as your property, cars and personal possessions.
So, if your Estate is valued at £475,000 when you die, then £325,000 would be free of IHT. The rest of it – i.e. £150,000 – would likely be taxed at 40%, which means an IHT bill of £60,000.
Since 6 April 2017, however, an Additional Threshold (AT) has been in place which can reduce your tax bill. This new threshold allows you to pass on an extra £150,000 in 2019-20 to direct descendants (e.g. children or grandchildren) in the form of your residential property.
Let’s see how this would affect the example above. Suppose this person’s £475,000 Estate consists entirely of their home. Assuming they pass this property onto a direct descendant, the whole Estate would likely be free from Inheritance Tax. This is because it would fall under the combined thresholds (i.e. £325,000 NRB + £150,000 AT = £475,000 allowance).
Each person has their own Nil Rate Band and Additional Threshold. That means you have your own NRB and AT, and if you are married then your spouse does too (the same applies in civil partnerships).
When you combine these allowances together it means that you can effectively double the amount you can pass on to beneficiaries, Tax-free, via an Inheritance:
Person A: £325,000 NRB + £150,000 = £475,000
Person B: £325,000 NRB + £150,000 = £475,000
Total Tax-free allowance (2019-20) = £950,000
So, if you and your spouse / civil partner own a £900,000 home and pass it to your children when you die, then you should be able to do so, Tax-free, assuming everything is in order, and the remainder of your Estate is less than £50,000.
Remember, your unused allowances pass on to your spouse if you die before them. You do not need to both die at the same time to combine your NRB and AT allowances!
Bear in mind that you cannot combine your IHT allowances in this way if you and your partner are unmarried, or not in a civil partnership. This is the case even if you have lived together for a long time and have children.
Pensions are primarily intended to provide you with an income when you retire. However, they can also be an important part of your IHT strategy. Remember we mentioned that your “Estate” comprises assets such as your property, cars and personal possessions? Pensions are notably absent from that list.
That’s because your pension does not form part of your Estate for IHT purposes. So, if you have a £750,000 house and a £300,000 pension pot when you die, the former might be liable to Inheritance Tax. The latter will likely not be.
You can pass on your pension pot to your beneficiaries, Tax-free, if you die before the age of 75. If you die after that age then the pot still does not face IHT. However, your beneficiaries will have to add any money they receive from your pension to their income. That means that they could face a higher Income Tax bill.
With some careful financial planning, you can therefore potentially pass on more of your wealth to your loved ones via your pension pot(s). Please note that you cannot do this with Final Salary pensions or Defined Benefit pensions.
The IHT rules in 2019-20 allow you to give away up to £3,000 per year, Tax-free. Think about that. Over five years that amounts to £15,000. Over fifteen years it totals £45,000.
You could ignore this allowance but consider that £45,000 taxed at 40% IHT amounts to £18,000 that could have otherwise gone to your family. So gift-making is not a strategy to dismiss lightly.
We can help you understand the current allowances and how they impact on you and your family. One annual exemption that is often missed is for wedding gifts. Here, you can give up to £5,000 (Tax-free) to your child for their wedding day (£2,500 for a grandchild or great-grandchild).
The above examples are just a handful of tactics to consider when thinking about Estate planning for your beneficiaries. Other options which might be appropriate for you include using Trusts and taking out a Life Insurance policy.
The rules surrounding Inheritance Tax are quite complicated and are subject to change. You could easily miss an important consideration if you try doing everything yourself, especially if you have a large complex estate.
Please do get in touch if you wish to discuss any aspect of the above in more detail.