Taxes are never popular. However, when it comes to the most widely despised tax, death duties or inheritance tax, usually comes up trumps. The reason for this is it is human nature to want to pass our hard-earned, accumulated wealth down to our children. Given that those who have departed spent a lifetime paying taxes (usually in numerous forms), it is no wonder having to pay another chunk of money to the Treasury after death is such a despised concept.
Not only is inheritance tax seen as unfair, but it is also blamed for distorting investment decisions, driving investments offshore and creating ludicrously complex tax reliefs, such as the new ‘residential nil rate band’.
As a result of the criticism, the Office of Tax Simplification, an independent adviser to the Treasury, has been urged by the Chancellor to come up with proposals to simplify inheritance tax, to ensure it is fit for purpose and to make interacting with it as smooth as possible. Taxpayers are encouraged to email their thoughts and experienced to ots@ots.gsi.gov.uk.
While the government takes suggestions and looks at making changes (a process which is likely to take years, let’s look at three steps you can take now to reduce your inheritance tax bill.
One- Make sure you have a valid Will
Unless you have a valid Will, it is almost impossible to undertake any substantial tax-planning. Nearly 60% of adults in the UK do not have a Will, with a fifth saying they have not bothered to draft one because they do not think they are wealthy enough[1].
Even if you do not own property, having a valid Will is essential to ensure your treasured possessions go to the person you wish to have inherit them, and are not divided in accordance to the Rules of Intestacy. And if you have children, a Will is imperative to ensure guardians of your choice are selected to take care of them if something were to happen to you and your spouse/partner, leaving them orphaned.
When it comes to planning for inheritance tax, your Will is the foundation document for detailing who will inherit your property and assets. By instructing a solicitor to draft your Will, you can take their advice on how to best distribute your wealth to ensure minimum inheritance tax is paid. To do this effectively, you need to understand your inheritance tax relief entitlements.
Two- Learn about your tax-relief entitlements and make sure you take advantage of them
Because the rules are so complex, a worrying number of people do not understand their tax relief entitlements. However, if you wish to effectively plan to minimise your inheritance tax obligations, it is vital you understand the relief you can claim.
As at the time of writing, the basic calculation of inheritance tax is as follows:
- Your estate will owe 40% on anything over and above the £325,000 Inheritance Tax threshold when you die.
- If you leave 10% of your estate to charity, the Inheritance tax owned is reduced to 36%.
- A married couple can pool their tax-free band together if they leave their estate to one another. So, if one spouse passes on their estate of £650,000 to the other, upon the latter’s death, there is no Inheritance Tax to pay.
The Main Residence Nil-Rate Tax Band
In April 2017, the Main Residence Nil-Rate Band came into force. Although it could save the children of a married couple up to £80,000 in inheritance tax, rising to £140,000 by 2020/2021, it is a complex calculation.
The Main Residence Nil-Rate tax band works like this: from 6th April 2017, provided you pass your family home onto your direct decedents, the first £100,000 of the property’s value will be tax-free. This threshold will rise by £25,000 every year to £175,000 by 2020/21. Therefore, in April 2018, the nil-rate band will total £125,000.
To qualify for the Main Residence Nil-Rate Tax Band, the following conditions must be met:
- You must have lived in the property at some point. Buy-to-lets are unable to attract the Main Residence Nil-Rate Tax Band. If you own multiple properties, the tax relief can only be applied to one of them.
- The property must be left to your ‘direct decedents’ which can include children, grandchildren, step-children, adopted children, foster children, and the spouses of these people.
- If your estate is worth more than £2 million, the Main Residence Nil-Rate Tax Band is reduced by £1 for every £2 that the estate is valued over £2 million.
If a surviving spouse were to die in May 2018, their estate would receive an inheritance tax relief of £775,000.
Three – Understand your gifting entitlements
Another method employed for minimising inheritance tax is to gift a proportion of your estate while you are still alive.
If you make a gift of money or assets to your children or other family members, as long as you survive for seven years after the gift was made, it will not be subject to inheritance tax. You are also permitted to gift up to £3,000 per year, which will not be subject to inheritance tax. Gifts valued at £250 or less are not subject to inheritance tax.
You can gift £5,000 tax-free to your child as a wedding present, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else, as long as the gift is made before the wedding and the wedding actually occurs.
In addition, gifts to help pay the living costs of an ex-spouse, an elderly dependent, or a child under 18 or in full-time education are exempt. To ensure you are granted the exemption, it is imperative you keep records of the gifts and make the payments on the regular basis. One common way this is done is for grandparents to pay for their grandchildren’s school fees.
Final words
We look forward with anticipation to the simplifying of the inheritance tax rules. In the meantime, if you have any questions on how to plan under the current system, we would be happy to talk with you.
Hart Reade Solicitors is a full-service law firm with offices in Eastbourne, Hailsham, Polegate and Meads. We hold a Lexcel accreditation from the Law Society of England and Wales and are a member of The Association of Lifetime Lawyers. To make an appointment with one of our private client solicitors, please phone our office on 01323 727 321.
Please note, this article does not constitute legal advice.
[1] http://www.thisismoney.co.uk/money/news/article-3807497/Nearly-60-Britons-not-written-will.html
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Please note the above is for information purposes only and is intended to be a short summary. It should not be treated as a comprehensive guide and should not be acted on without qualified legal advice.
