Inheritance Tax (IHT) can have a significant impact on the amount you leave behind for your loved ones. To ensure that your beneficiaries receive the maximum possible benefit from your legacy, it’s essential to consider the implications of IHT and take steps to minimize its effects through inheritance tax planning.
In the past few months, you have learned about the fundamentals of estate planning and determining the worth of your estate. It is crucial to include the reduction of an IHT bill as a significant aspect of your estate plan if you might be held accountable for it. Keep reading to discover when IHT payments are required.
The standard rate of Inheritance Tax is 40%
With a standard rate of 40%, IHT could substantially reduce the value of what you leave behind for loved ones. According to HMRC, around 3.76% of estates pay IHT. Inheritance tax is a tax on your estate after you pass away if the total value exceeds certain thresholds. There are two allowances that you could use:
- If the value of your estate is below the nil-rate band, your estate will not be liable for IHT. For the 2023/24 tax year, it is £325,000.
- Should you leave your main home to your children or grandchildren, you may also be able to use the residence nil-rate band. For the 2023/24 tax year, it is £175,000.
As a result, it is possible to pass on an inheritance of up to £500,000 before becoming subject to IHT payments. Furthermore, you have the option to transfer any unused allowances to your spouse or civil partner. If you plan your estates jointly, it is feasible to pass on assets worth as much as £1 million before incurring IHT obligations. Any part of your estate that surpasses these thresholds typically incurs a 40% tax.
Suppose you pass down assets valued at £600,000, including your primary residence, to your child to benefit from the residence nil-rate band. The initial £500,000 of the inheritance can be transferred without incurring any tax obligation. Nonetheless, the remaining £100,000 that surpasses the allowances would be subjected to a tax charge of £40,000.
You should note both the nil-rate and the residence nil-rate band are frozen at the current level until April 2028. While the value of your estate is below the threshold now, will this still be the case in five years? To plan effectively, you should consider how the value of your estate could change.
A plan is essential if you want to mitigate Inheritance Tax
There are often steps you can take to reduce a potential IHT bill. Creating a plan now could mean your loved ones inherit more of your estate. There are lots of steps you can take to reduce IHT during your lifetime, including:
- Gift assets during your lifetime. You could support your loved ones by gifting assets now or during your lifetime. However, keep in mind that only some gifts will be outside of your estate for IHT purposes immediately. Others may still be included when calculating IHT for up to seven years. Contact us to discuss how to gift to reduce IHT liability now.
- Place assets in a trust. Placing assets in a trust could mean they are outside of your estate and, in some cases, you may still be able to benefit from the assets. You will need to name a trustee that will manage the assets on behalf of your beneficiaries. Trusts can be complex, especially if you need to consider IHT, so professional advice can be useful.
- Leave some of your assets to charity. This could bring the value of your estate below the IHT threshold. If you leave more than 10% of your entire estate to charity the IHT rate will fall from 40% to 36%, which could lower the bill for some families.
- Keep the value of your estate below the IHT threshold by spending. Maximize your later years by increasing your spending, as it can help you reduce your potential inheritance tax liability if it results in your estate’s value falling below the IHT threshold.
In addition to the strategies for mitigating IHT, there may be other options you can explore to manage your estate and plan for the payment of any potential tax bill. It may be worthwhile to seek professional advice to create a tailored estate and IHT plan that aligns with your specific goals and circumstances. This could involve setting aside funds to cover the IHT bill, and ensuring that your family has access to the necessary resources when they need them.
Another possible solution to cover an IHT bill is to consider taking out a life insurance policy. By paying premiums, the policy proceeds can provide your family with the necessary funds to cover the potential IHT liability. It is important to ensure that any life insurance policy intended to cover IHT is written in trust. If it is not, the payout will be considered part of your estate, which could increase the amount of IHT due. Therefore, placing the policy in trust ensures that the proceeds are paid directly to the beneficiaries, outside of the estate, and are not subject to IHT.
Contact us to talk about your estate plan and Inheritance Tax
If you’d like help understanding if your estate could be liable for IHT, or you want to discuss your options to potentially reduce a bill, please get in touch.
While estate planning often focuses on organising your affairs to pass on assets when you die, it can also cover steps to improve your long-term financial security. Next month, read our blog to discover what steps you could take to make your later years more secure.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The Financial Conduct Authority does not regulate estate or tax planning.
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