Keeping wealth within the family is desirable but not always easy to plan. There is a myriad of Inheritance Tax (IHT) rules to mitigate and these are often complicated and subject to change. As Financial Planners, we are here to help clients navigate this complex landscape and leave a meaningful legacy for their loved ones, without paying unnecessary tax.
In this short guide, our financial planning team will be sharing some ideas on how clients with complex estates can leave their wealth to younger generations.
The Inheritance Tax (IHT) threshold, also known as the nil-rate band (NRB) refers to the threshold after which you start paying IHT (usually 40%) on the value of your estate. In the 2019-20 tax year, this is set at £325,000 and includes the value of your home. So, if your estate is worth £500,000 when you die, then £175,000 is potentially liable to be taxed at 40%.
However, there are a number of IHT rules which can affect your threshold, and how much you pay. First of all, married couples and civil partnerships can inherit any unused IHT allowance from their deceased spouse. If they have not previously used any of this allowance, then the surviving spouse can effectively “double” their IHT threshold to £650,000.
Secondly, there is also an important caveat regarding your home. If you pass on your family home to direct descendants (e.g. children or grandchildren) when you die, then you can raise your IHT-free threshold using an additional nil-rate band (ANRB). In 2019-20, this allows each individual to pass on an extra £150,000, tax-free.
Again, married couples and civil partners can combine their ANRBs to potentially shield £300,000 of property value from the tax man. It’s also worth noting that this threshold will be raised to £175,000 in April 2020, which could allow couples to pass a £1m estate to their direct descendants completely free of IHT. For many people living in the South East this is welcome news in light of rising property prices, which might have tipped their estate over the IHT bar.
It may sound strange to focus on pensions in an article about estate planning, but they can be a vital tax-saving tool. Under current rules, your pension is excluded from the value of your estate for IHT purposes, allowing you to potentially pass hundreds of thousands of pounds to your loved ones without these funds being potentially liable to IHT.
However, you do need to be careful with this and we recommend speaking to one of our experienced financial planners to ensure your pension is properly integrated into your estate plan. For instance, final salary pensions rarely (if ever) can be inherited by children, although there are often reduced benefits for a surviving spouse. Your state pension, moreover, cannot be passed down to your children or to your husband, wife or partner.
It is those with defined contribution pensions who can primarily make use of this part of the IHT system. Even then, however, there can be tax implications. If you die before the age of 75, for example, then under current rules your beneficiaries can receive any pension funds tax-free. If you die after this age, however, then it might affect their Income Tax bill (possibly pushing them into a higher tax bracket).
There are a range of other IHT-mitigation tactics open to people with complex estates, depending on your personal circumstances:
Do give us a call if you wish to discuss this area of advice in more detail!