Whether you like it or not, life has a predictable outcome – we’re all going to die at some point.
What you leave behind may be subject to inheritance tax before anything is passed on to your heirs depending on the value of your ‘estate’.
Official calculations of the net worth of your estate take into account your property, vehicles, investments, any business assets, life insurance payouts, and cash in the bank. There is a nil band threshold of £325,000 after which a flat rate inheritance tax rate of 40% applies.
In addition, a new ‘main residence nil rate band’ has recently been introduced to cover the family home. Applicable only to direct descendants of the deceased, this is currently set at £100,000, increasing each year by £25,000 until it reaches £175,000. From 2020 onwards, family homes will be protected up to the value of £500,000.
Inheritance tax is a complex subject that could cost your heirs dearly. But while your tax exposure can add up to a substantial amount, the good news is that some expert inheritance tax advice and a bit of clever financial planning on your part can mitigate your tax exposure or possibly eliminate it altogether.
Here are 5 perfectly legitimate ways that you can pay less inheritance tax.
Gifting to your partner
Making a gift to your husband, wife or civil partner is tax free. There is no limit as to the value of such a gift and you can make it anytime. This mechanism can be used to reduce the value of your estate so that there will be less inheritance tax to pay.
Gifting to family or friends
You can make an annual tax free gift of £3,000 to other family members, friends or anyone else for that matter. There are also additional tax free allowances for wedding gifts to your children or grandchildren.
Furthermore, you’re free to make larger gifts as you see fit. However, in this situation, the gift will only be tax free if you survive for 7 years after you’ve made the gift. In the meantime, the monetary value of the gift will still be part of your estate, with progressive tax relief applying from year 3 onwards.
Say you’re gifting a property to your son but pass away a year later, the value of the property will be included in your estate for the purposes of calculating inheritance tax payable. However, if you die 8 years after making the gift, there will be no tax liability arising from the gift.
Setting up a trust
Setting up a trust can be a great way to tax shelter your estate, and you can specify exactly what you would like the money to be used for – paying school fees for your grandchildren or supporting a disabled family member, for instance.
A trust can be set up at any time, although you may be liable to capital gains tax when transferring assets into a trust while you’re alive. However, this won’t apply if you establish a trust in your Will.
Establishing a trust is a complicated business and it’s unlikely that you’ll be able to find your way through all the complicated rules without assistance. Talk to an experienced accountant and solicitor with a specialisation in trusts and inheritance tax.
Gifting to a charity
Given the choice, would you rather give money to a charitable cause or the taxman? Making a charitable bequest in your Will is a tax efficient way to lower your inheritance tax bill, since charity giving is entirely tax free.
Better still, if you decide to give at least 10% of your entire estate to charity, the inheritance tax rate for the remainder of your taxable estate will drop to 36% – which could be worth doing.
Taking out life insurance
Taking out life insurance to cover your inheritance tax liability is a clever way to ensure that the money is available to pay the tax bill as and when needed. However, take great care to set up a whole-of-life insurance policy, making sure you write it in trust. That way, the value of your estate will be reduced by the value of the policy when it pays out.
Unless you put your life insurance in trust, the value of the policy will be added to your estate and have the opposite effect of what you wanted to achieve.