Inheritance Tax Planning: No Time to Wait17th November 2015
You don’t need to be rich for inheritance tax (IHT) to be an issue. In many parts of the UK, owning your home alone pushes you above the threshold.
IHT Threshold and Rates
The key numbers to know are £325,000 (IHT threshold) and 40% (IHT rate).
The first £325,000 of an individual’s estate are tax-free. This is called the “Nil Rate Band” (NRB). Anything above the threshold is taxed at the high rate of 40%, which may be reduced to 36% if at least 10% of the estate is left to charity.
Married couples and civil partners enjoy double the allowance and can pass assets worth up to £650,000 to their children or other beneficiaries.
In the last decades, (even the double) IHT threshold has considerably lagged behind average house prices. It has been completely frozen since 2009. Finally the Chancellor announced an increase in the 2015 budget. However, the extra £175,000 (per individual) will only apply to the main family home and will only come into full effect in 2020/2021.
It is clear from the above that leaving everything in your estate and paying the 40% tax at death is a fast way to destroy family wealth and one’s legacy. Avoiding inheritance tax is one of the most frequently asked questions in financial planning. Luckily, you don’t need to hide assets in tax havens or break the law.
Gifts and the 7-Year Rule
Gifts are the simplest and most powerful way to pass assets to your children without triggering excessive taxes. This is how rich families have been able to maintain their wealth and pass it across generations.
There is another key figure to know: 7 years.
You (or your beneficiaries) can’t simply say that you have given them your entire estate as a gift shortly before your death and avoid IHT. A period of 7 years needs to pass from the moment of making the gift to your death, in order for the assets to be exempt.
If you die within the first 3 years, full IHT will be paid. If you die between the 3rd and the 7th year after making the gift, the tax will be reduced by 20% for each year, with the original full 40% IHT rate going down to 32%, 24%, 16%, 8% and eventually zero. This is known as the Taper Relief.
It is important to keep in mind that during the 7-year period the gift counts against the IHT threshold and uses up part or the whole of your Nil Rate Band, possibly pushing the rest of your estate to the full 40% IHT rate.
Another problem with gifts is that they are typically irreversible and inflexible. When making a gift, you lose control of the assets. This may not look like a problem, as long as the assets remain in the family and all the relationships are good and unchanged. Unfortunately, various unexpected issues may arise, such as death of the beneficiary, divorce, deteriorating health and the need for expensive care, or some other family emergency. These are common reasons why people often (rightfully) hesitate with IHT planning and taking action. There are tools such as flexible reversionary trusts, which may enable you to enjoy the tax advantages of gifts while retaining flexibility and managing the risks.
Estate planning is very complex. Avoiding inheritance tax is obviously a big part of it, but it should not be the only concern. Without experience, it is easy to overlook important risks and other factors. This is where a professional estate planner can be helpful.
No Time to Wait
Like with most other unfavourable things in life, when addressing the issue of inheritance tax the best results are rarely achieved by waiting and inaction. Regardless of your age and health, if you have assets of substantial value, the best time to start IHT planning is now. Don’t make the same mistake as many others and don’t leave it for old age.
The younger you are and the longer your life expectancy, the greater difference proper IHT planning can make for you and your family. Conversely, the longer you wait, the narrower your options will become and the higher taxes your beneficiaries will have to pay.Share: