The starting point is to formulate an estate plan that minimises your tax liability. Payments of inheritance tax continue to rise steadily and the total received by HMRC in 2015/16 exceeded £4 billion for the first time.
There are a number of ways in which the tax liability can be mitigated and the main ones are summarised below:
Utilising the nil rate band
Inheritance tax is generally payable where a person’s taxable estate exceeds £325,000. This can be increased to up to £650,000 on the transfer of any unused nil rate band to a surviving spouse.
However, unmarried couples cannot benefit from the transfer of unused allowance so you should ensure that it is used in full on the first death.
Main residence nil rate band
From April 2017 there will be an additional nil rate band of £100,000 rising to £175,000 in April 2020. This is available when passing on the main residence to a direct descendant on death.
As with the main nil rate band, this can be transferred to a surviving spouse, so from April 2020 there is the potential for a total nil rate band of £1 million.
However, the additional nil rate band is reduced for estates with a value of £2 million before reliefs, so you may need to consider reducing the value of your estate by planning during lifetime.
Making use of IHT exemptions
You should ensure that you make the best use of the available lifetime exemptions, which include:
- Annual Gifts – You can make gifts up to £3,000 each tax year.
- Small gifts to the same person – Outright gifts to an individual in a tax year are exempt up to a total value of £250 and there is no limit on the number of recipients.
- Gifting out of income – Gifts are exempt from inheritance tax if they are regular in nature and are made from excess income such that the donor maintains their usual standard of living. Any outright gifts in excess of the above amounts will also be exempt from IHT if you survive the gifts by seven years.
Many individuals prefer to make gifts to trust in order to retain control over the gifted asset and protect the asset from, for example, divorce or bankruptcy. Such gifts are usually limited to the nil rate band of £325,000 as any excess is subject to an immediate 20% tax charge.
The trust assets are not considered to belong to any of the beneficiaries until they leave the trust and will not therefore be taxable on the death of any of the beneficiaries.
Skipping a generation
In the majority of cases assets are left to children on the basis that they can pass it on to their own children if appropriate. However that would not be tax efficient if the children already have accumulated wealth in excess of the nil rate band. Instead property can be left direct to grandchildren or a trust for their benefit.
As well as ensuring that your assets will be distributed in accordance with your wishes a will can be a powerful planning tool.
Having taken the time to make a will and prepare an estate plan, you must review them regularly to reflect changes in family and financial circumstances as well as changes in tax law.