Estate Planning. How to protect and pass on your wealth
Think inheritance tax doesn’t apply to you? Think again! There is a common misconception that inheritance tax affects only the wealthiest, but with rising property prices over the past decade more and more families are being affected, possibly without being aware of it.
Without any estate planning, your beneficiaries could be faced with a large 40% tax bill when you die. They might even be forced to sell assets such as the family home, to pay the bill. But with some forward planning you can help ensure that the people you want to benefit from your estate actually do.
What is Inheritance Tax?
Inheritance tax is a one-off tax that is paid on the estate of someone who has died. Your estate is basically everything you own including your property, money, possessions such as cars, life assurance policies and other investments as well as personal effects such as jewellery.
Inheritance tax is paid on the value of your estate above a certain threshold, which is currently set at £325,000. If you give away your home to your children (including adopted, foster or stepchildren) or grandchildren, your threshold could increase to £475,000 (2019/20 tax year).
There is normally no inheritance tax to pay if the value of your estate is below the threshold or if you leave everything to your spouse, civil partner or charity.
Inheritance tax is currently set at 40% of the value of your estate over £325,000 (or £475,000) and is payable by the executors of your estate.
To work out how much inheritance tax, if any, needs to be paid, the executors of your estate need to add up the value of all your assets, then subtract any debts, bills and funeral expenses.
Ways to reduce inheritance tax
Spending your hard earned cash is and remains the simplest way of reducing your taxable assets. It may sound too simple but many people often come to talk to us about their inheritance tax planning and it never crosses their mind that they can afford to spend more and live the life they want.
We start by helping our clients to quantify how much money they’ve got and how this ties in with their lifetime goals. We use sophisticated cash flow modelling software to visualise your future financial situation and if the scenarios suggest that you’ve got enough money to fund the lifestyle you want now and in the future, we’ll let you know so that you can spend more of your hard earned money on chasing your dreams and aspirations.
Gifting to your children or grand-children is another way to reduce inheritance tax, but careful consideration should be taken into account when making gifts, as these could become liable to inheritance tax were death to occur within 7 years of the date that the gift was made. There could also be other tax consequences to consider, such as Capital Gains Tax or Stamp Duty Land Tax on a gift of property.
You can gift your assets away to mitigate your inheritance tax liability, up to a total value of £3,000 per year (the ‘annual exemption’). Any leftover annual exemption can be carried over from one tax year to the next, but only to the next tax year.
You can also make small gifts (up to £250) to as many different people as you like, but you cannot use your annual exemption and your small gift exemption on the same person in the same year.
Certain gifts don’t count towards the annual exemption and no inheritance tax is due on them, such as wedding (or civil service) gifts worth up to £5,000 given to a child, £2,500 given to a grandchild or great-grandchild and £1,000 given to anyone else. Any gifts (with no restriction) can be made free from inheritance tax to charities, political parties, universities and for public/national benefit.
Trusts are a more complex financial planning tool but undoubtedly have their place for many people. They can be especially attractive for those who don’t want to ‘lose control’ of their assets or want to ensure they remain within their ‘bloodline’.
With some Trusts, you have to forgo access to some or all of the original capital as well as any future growth. There are also limitations on how much can be placed into trust, as under some circumstances an immediate ‘entry’ inheritance tax charge could apply.
There could also be certain tax charges on ‘exit’ of a trust as well as ‘periodic’ charges in some circumstances, so it is important to take professional advice if you are considering trusts as part of your inheritance tax planning.
Gifts with Reservation of Benefit
It you gift an asset but retain some benefit, it may be treated as still being within your estate on death. For example, gifting a property into a Trust (or an outright gift) to your son or daughter without paying a market rent to them could be considered a Gift with Reservation of Benefit.
Therefore, careful planning around the formality of gifts into Trust should be considered, the general rule is if something sounds too good to be true, it usually is!
Anything you leave to Charity is free from inheritance tax. Also, were you to leave at least 10% of your estate to Charity in your Will, the rate by which inheritance tax is calculated can be reduced from 40% to 36%.
5. Life Insurance
This is useful for people who do not wish to gift away or lose control of their assets. By taking out a life insurance contract this does not reduce the inheritance tax liability, instead it provides funds to meet the cost of it.
Such insurance policies should also be placed into a suitable Trust structure, so that the policy proceeds do not form part of your estate on death and also to provide funds quickly to your beneficiaries to meet the liability.
As the proceeds fall outside of the estate, the trustees have access to them without having to wait for a grant of probate, this can ensure prompt payment to your beneficiaries, if the trustees decide this to be appropriate.
An often misunderstood fact that many people don’t always realise is that many defined contribution pension plans are held under a master Trust arrangement and therefore are not automatically included as part of an individual’s estate for inheritance tax purposes.
Saving into pensions can therefore be a tax efficient way to accrue wealth whilst also improving the inheritance tax efficiency of the estate. What is important to note here though, is that the age and type of the scheme will depend on how the death benefits of the pension are paid out on first death, which could cause assets to form part of an individual’s estate further down the line.
Careful consideration should therefore be taken on how the death benefits of any pension are structured. Final Salary pension schemes require additional levels of consideration.
Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.
Introduced as part of the 1976 Finance Act, a relief known as Business Property Relief (BPR) was created to allow small businesses to be passed down through the generations without facing a large inheritance tax bill. Investments in these qualifying companies can benefit from government inheritance tax reliefs, which if held for at least two full years, could be exempt from inheritance tax in full.
The benefits when compared with other inheritance tax mitigation strategies is faster exemption, greater access, control and simplicity. However, these are generally seen as high risk investments and so in most circumstances could be considered for a small proportion of the total estate.
Business property Relief Schemes (BPR) invest in assets that are high risk and it can be difficult to sell such as shares in unlisted companies. The value of the investment and the income from it can fall as well as rise and investors may not get back what they originally invested, even taking into account the tax benefits.
Tax treatment varies according to individual circumstances and is subject to change.
8. Equity Release
Due to rising property prices many people find that most of the value of their estate is tied up in their property and so turn to Equity Release schemes as a way to unlock this capital.
In some circumstances, Equity Release can improve the inheritance tax efficiency of your estate. As the name suggests, Equity Release works by releasing equity from property in the form of a loan. This loan can help people with little or no ‘liquid’ assets or income to meet their ongoing expenditure needs, by providing capital in the form of a loan that is repayable on death.
An ideal scenario could be someone with a large amount of equity in their property(s) who does not wish to move away from their home but also does not have sufficient income or liquid capital in retirement.
Equity Release will reduce the value of your estate and can affect your eligibility for means tested benefits.
9. Draw an up to date Will
Many people wrongly believe that their whole estate will go to their spouse or civil partner when they die. However this is only the case if a suitably drafted Will has been drawn up to specify this. Marriage, civil partnership, divorce and dissolution can all have an impact on an existing Will.
Although drafting a Will may not directly mitigate an existing inheritance tax bill, an up to date Will should always be considered when estate planning, to ensure that you don’t die ‘intestate’ and that your assets are distributed according to your wishes, not for the law to decide. It can also help to speed up the distribution of your assets to your loved ones after your death. Riverfall Financial doesn’t do Wills, this service is provided by solicitors.
There is no ‘one size fits all’ solution when it comes to estate planning as people are different and have varying opinions, objectives and appetite for risk. It may be that a combination of the above strategies are incorporated within a Financial Plan to help you achieve your overall objectives and wishes.
Information within this Guide is based on the current 2019/20 tax year and our current understanding, which can be subject to change without notice. The accuracy and completeness of the information cannot be guaranteed. It does not provide individual tailored advice and is for guidance only. It is important to take professional advice before making any decisions relating to your personal finances.
What’s your next step?
To find out more about how we can help you with your estate planning, visit our Estate and Inheritance Tax Planning page.
We offer all prospective clients an initial discovery meeting with one of our financial planners at our expense, to see if we can be of help to you.
Book your free initial meeting today, if you want to protect your wealth for your loved ones and need specialist advice.