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Inheritance tax (IHT) is one of the UK’s most notoriously complex taxes. It also touches on some sensitive topics in family discussions, since estate planning concerns “who gets what” when the owner dies. However, the subject must be tackled and it’s important to leave the best legacy you can to your loved ones.
In this 2022 guide, our team at Elmfield (financial planners in Padiham, Burnley, Lancashire) outlines how IHT works and ways you can legitimately reduce a bill. We hope this is helpful to you. If you’d like to speak to an independent financial adviser then you can reach us via:
T: 01282 772938
What is inheritance tax (IHT)?
IHT is the tax levied on the value of your “estate” (e.g. property, possessions and savings) when you die. In 2021-22, IHT typically stands at 40% on a person’s estate once the taxable assets exceed £325,000. For instance, if you do not own a home and have £500,000 in investments within a general investment account (GIA) or ISA when you die, then £175,000 is likely subject to 40% IHT – leading to a £70,000 bill. Your executor(s) will administer the estate after you pass away. These people are often specified in a will, but if there is no will then the state will assign administrators to deal with things (although they may not handle everything efficiently).
Can’t I just avoid IHT using the “7 year rule”?
Many people are under the impression that they can simply avoid IHT by giving everything away 7 years before they die. The problem, of course, is none of us knows when our time will come! You might die 3 years after making your gift(s), for instance, in which case IHT will usually still apply (albeit at a reduced rate – i.e. 32% instead of 40%).
Another misconception is that you can simply put everything into a trust and avoid IHT that way. Things are not this simple. Many different trust types exist in the UK, and each has its own rules and IHT treatment. Trust law is complex, and you could make an irreversible mistake if you rush ahead and commit assets to the wrong type. Bear in mind that any assets placed into a trust will – at the very least – be under less of your direct control. Seek professional advice first.
Can I pass down my family home?
One way to mitigate an IHT bill (for homeowners) is to specify that you wish for your main home to pass down to “direct descendants” when you die – such as children or grandchildren. In the 2021-22 tax year, this allows you to pass down an additional £175,000 to your beneficiaries free from IHT. Taken together, a single person could, therefore, bequeath up to £500,000 in this way without paying a single pound in IHT.
For married couples and civil partners, the IHT rules are even more advantageous. Here, you can combine your IHT allowances since any unused allowance can be passed to your partner when you die. As such, a legal couple could pass down up to £1m to their direct descendants without IHT – using careful estate planning.
What if my home is over £1m, or I do not own property?
Of course, this will not be enough for every estate owner. Some couples may have a family home worth over £1m. In which case, additional planning measures are needed to avoid the property’s inevitable sale (to cover the IHT bill). Others cannot benefit from these IHT rules, perhaps because they rent and hold no equity in property.
Here, you may want to explore different options with a financial planner. The latter person (or legal couple), for instance, may want to explore buying a home as they enter retirement. Not only can this reduce the amount you need to save into a pension (since you will no longer be renting), but it also lets you access the extra £175,000 IHT-free allowance mentioned above.
Another option is considering a life insurance policy – written into an appropriate trust – which pays out a lump sum when you die. Here, the funds can be used to settle an expected IHT liability. A financial planner is often necessary to explore this option, since you need to be sure about your likely IHT bill (not easy to estimate) and the monthly premiums for the policy may end up totalling more than simply paying the future bill out of other savings/assets.
For most people, exploring the UK’s rules on gifts (relating to IHT) can be a powerful pillar in your estate plan. In 2021-22, you can make up to £3,000 in gifts – either to one person, or to multiple people – without these counting as part of your estate for IHT purposes. You can also make as many individual £250 gifts as you like, and under certain conditions wedding gifts are also IHT-free.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
