In 2017, £5 billion was paid in inheritance tax. That represents the highest amount ever raised from UK taxpayers. However, although the number of people paying inheritance tax is rising, most people still won’t have to cover this cost. Currently around 30,000 estates are subject to inheritance tax each year and the rest don’t meet the threshold. That’s not to say that this won’t change – particularly given the increases in the values of property over the past decade, many more people could soon leave behind an estate of enough value to meet the minimum threshold for inheritance tax. So, what can you do to legally avoid or reduce that potential bill?
What does inheritance tax involve?
£325,000 – this is the base figure that can be passed on without attracting any inheritance tax for an individual. This jumps to £650,000 for couples who are married or in a civil partnership. If you’re a couple passing on your home then the addition of the Main Residence Allowance means you have an extra £125,000 to create a total individual allowance of £450,000, or joint allowance of £900,000. Once your estate passes the threshold, inheritance tax is due at 40%.
Although there are many different complexities involved in inheritance tax, perhaps the most important step to take if you want to ensure your estate avoids it is to make a Will. If you die without a Will then you die intestate and you will have no control at all over what happens to your assets when you die. That means that it’s impossible to do any estate planning or make smart decisions that could help you to reduce or avoid an inheritance tax burden.
Taking steps to reduce or avoid inheritance tax
Use a trust. You can transfer assets out of your individual ownership and into a trust before your death. The effect of this will be to remove those assets so that they are not considered as part of your estate when you die. Cash, property or investments can be placed in a trust for the benefit of someone like your spouse or children and won’t attract inheritance tax. If you’re going to use this option you’ll need to get legal advice on the type of trust to use and any taxes that it could attract.
Transfer assets as a gift to your partner. As long as you are married or in a civil partnership, and your spouse was born in the UK, then there are no limits on what you can gift to them.
Gift something to someone else. If you give a gift of cash, assets or property to anyone who is not your spouse or civil partner then this could be given free of inheritance tax. The “could” arises because this gift has to be given at least seven years before you die. For those seven years it will remain part of your estate and could be taxed. After the seven year period has passed it will no longer form part of the estate for inheritance tax purposes.
Consider a charitable donation. There are two financial benefits to making charitable donations in your Will. The first is that anything you donate will be inheritance tax free so this is a simple way to reduce your liability. Secondly, if you donate 10% or more of your estate to charity the rate of tax due on the rest drops from 40% to 36%.
Don’t scrimp and save. It doesn’t make sense to spend a lifetime accumulating assets and property only to then lose 40% to the government because you’ve gone over the threshold. Especially if you’re only just above the taxable amount it may be simpler to enjoy spending some of what you have now.
Pay more into your pension. You can leave your pension to anyone when you die, it doesn’t have to be to a spouse or partner. Although it will depend on your pension and when you die, your beneficiaries could pay no tax if you die before the age of 75 – or just their normal income tax rate if after (with the pension income added to their own taxable amount). There are different rules for different pensions so it’s worth taking independent financial advice.
A deed of variation. This is a document that can be used to alter your Will after death, for example to change what is inherited, and how. It’s not the best option, as it will require the agreement of all the beneficiaries but it could be a useful tool if all other attempts to reduce a large tax bill have failed.
Life insurance. Although not a way to avoid inheritance tax, a life insurance policy can be an essential option for reducing what your beneficiaries have to pay. The pay out under the life insurance policy can be used to cover the cost of the inheritance tax.
Inheritance tax isn’t inevitable for everyone. However, if your estate is affected it’s worth taking the time to try and reduce your liability.
Amanda Gillam is Solution Loans's General Manager and has been since 2009. She is also a prolific writer on personal finance issues, and has been quoted numerous times in articles published on 3rd party websites and in press releases. Her...Read more about Amanda Gillam