Inheritance tax and estate planning explained by Compare Wealth Managers...

While many of us think about leaving something for our loved ones when we pass, the process of making arrangements can be overwhelming, particularly when rules on taxes change. In this article, we have compiled the most important aspects to consider when organising your affairs in order to bring security to your family, and we describe how a wealth manager can help you reduce the impact of inheritance tax.

Making plans for a future we might not be a part of is not always comforting, but it is a necessary step to secure the well-being of our family in case we are not there to care for them. However, the impact inheritance tax has on your assets might reduce your estate considerably. Therefore, it is important to understand how our assets might be taxed in order to take the necessary steps today to maximise the value of the inheritance you leave.

Inheritance tax?

According to the UK Government, “Inheritance Tax (IHT) is a tax on the estate (the property, money and possessions) of someone who’s died”. The standard IHT rate is 40%, but it’s only charged on the part of your estate that’s above the threshold of £325,000 (also known as the nil-rate band).

You are exempt from paying the Inheritance Tax if either the value of your estate is below the nil-rate band, or if you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club. For example, if your estate is worth £500,000 and your tax-free threshold is £325,000, the Inheritance Tax charged will be 40% of £175,000 (£500,000 minus £325,000).

Can I give away some of my estate now to avoid the Inheritance Tax?

If you give away your home to your children (including adopted, foster or stepchildren) or to your grandchildren, your threshold can increase to £500,000. This means that IHT applies to anything over half a million pounds, so if, for example, your entire estate is worth £2 million, the 40% applies to the £1.5m left. IHT due on your estate is paid by your beneficiaries (the people you choose to leave your estate to) and must be done within six months of your death being recorded.

However, when someone leaves all of their assets to their spouse or civil partner, the nil-rate band also changes. So, when the surviving spouse or civil partner dies, they have a combined nil-rate band of £650,000 (£325,000 x 2) applied to the value of their estate. You can pass a home to your husband, wife or civil partner when you die, there’s no Inheritance Tax to pay if you do this. However, when you leave your home to another person in your will, it counts towards the value of the estate. You can also “gift” your house to someone while you are alive, and if you pass away more than 7 years after, the gift becomes tax-free. Before that timeframe, you can continue living in the property but have to pay rent to the new owners and pay your share of the bills. If you pass before the 7-year period, taxes on the house will apply.

Inheritance Tax Law Changes in 2022

The UK government hasn’t changed the 40% rate of inheritance tax since 1988 and hasn’t increased the IHT threshold (of £325,000) since 2009. There was an update this year where changes have removed the requirement for estates that are valued below the nil rate band to file any paperwork – these estates are now known as ‘excepted estates’. Under the 2022 IHT changes (applicable from 1st January), the estate is considered exempt if:

• it is worth £650,000 or less (with any amount over the nil rate band having been transferred from a spouse or civil partner who died first)

• the entire estate is worth less than £3m and was left to a spouse or donated to a UK charity (previously the maximum amount was £1m). Here, the definition of “spouse” was also revisited, and now includes people legally married to each other, including same sex couples, registered as civil partners and people who are legally married but separated at death

• the deceased was based outside the UK, in that case they have a nil rate band of £150,000 for the estate that is still in Great Britain

Why do my beneficiaries have to pay the inheritance tax?

Like any other tax, it is unpopular but necessary, however, IHT has been particularly disliked since it is traditionally considered, mistakenly, as a tax that only the very wealthy are required to pay. In fact, due to inflation and house price growth, many beneficiaries of all means, if unaware of the rules, can be burdened with large tax bills.

In addition, inheritance tax is usually paid on assets that have already been taxed at least once already, so many argue that additional tax is unjust, especially as it falls to the beneficiaries.

On the other hand, as we know, death and taxes are the only certainties in life (!) and IHT is an important source of revenue for the Treasury, used to pay for health, welfare and education that we all beneficiate from.

Is there a way to reduce the amount on the Inheritance Tax bill?

Working with an expert Financial Adviser or Wealth Manager can help you legally reduce the exposure of your estate to IHT. They will assess your circumstances and work with you to develop an effective plan factoring in your allowances, your assets and your age.

Some examples of how this can be done include gifting part of your money while you are alive. Gifting up to £3,000 a year tax-free forms part of your 'annual exemption' and can be given to an individual or split between several (you can also carry the unused amount forward for one tax year). In addition, you can donate up to £5,000 to your child's wedding day without it being included in your annual giving allowance. For a grandchild or great-grandchild, you can give £2,500 (the allowance drops to £1,000 for anyone else). As for any funds remaining within defined contribution pensions after you die fall outside of your estate and are exempt from IHT. Life insurance or a trust fund are great options to ensure your family receives the most out of your estate.

As described earlier in the article, the timing of the IHT strategy is important so creating a financial plan in good time will help to avoid unwelcome bills landing on unsuspecting beneficiaries.

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