When we're younger in years, we tend to want to save our hard-earned cash and build a nest egg for the future, to provide some security for our old age and to have something squirrelled away for a rainy day. But then as the years advance, we realise that our savings are vulnerable to outside influences, such as interest rates, fluctuating markets, complex family structures as well as creditors. In addition, with Inheritance Tax being paid at the rate of 40p in the £1, it's no surprise that as we get older we want to start thinking about how we can give our wealth away to benefit our family and loved ones and to mitigate exposing our assets to these risks.
This is where estate planning plays a part. Now, most people will not be familiar with the term "Estate Planning" and I expect you might be sitting there scratching your head; conjuring up an image of a vast Manor House in the countryside, surrounded by an extensive area of land which is owned by a wealthy family and wondering how this might have anything to do with you.
Well actually, Estate Planning is relevant to all of us, regardless of how much wealth we might possess. Estate Planning sits alongside making your Will and is a key part of putting your affairs in order for later in life. Most people will want to provide financial security for themselves and their loved ones whilst also reducing tax liabilities. This can be achieved with the right Estate Planning.
So, let's have a look at how you can share your wealth now. The Bank of Mum and Dad and its closely connected relative; the bank of Grandma and Grandpa remain reliable sources of cash gifts and are often the lender of choice. But giving away money does need careful thought and without the correct planning, can have dire consequences on a person's inheritance tax bill.
Let's coin the phrase written by Benjamin Franklin, "in this world, nothing is certain except death and taxes".
Yes, I hear you, it all seems a little unjust, when you've worked hard all of your life, paid tax on your earnings, paid tax when you spend your earnings, pay tax to live in your home, pay tax to sell your home, only to then be taxed when you die. And if that's not bad enough, it's worth noting that Inheritance tax is not just a death duty but is also charged on some lifetime transfers at a rate of 20p in the £1. So, how will Inheritance Tax affect you?
The good news is, very few estates are subject to Inheritance Tax, in fact only around 4-5%. Much of this will be down to a carefully written Will, sound estate planning decisions and utilising as many exemptions and reliefs as are available.
Inheritance Tax - What is the Magic Million £
Want to know how you can have a million pounds but not have to pay Inheritance Tax? Well here's how.
The Standard Nil Rate Band
The Standard Nil Rate Band (NRB) is available to everyone and allows an individual to gift a maximum of £325,000 Inheritance Tax (IHT) free, whether this gift is made in a person’s lifetime or upon their death.
The Transferable Nil Rate Band
If a person is married or in a civil partnership when they die, then they will also have the ability to pass on any unused Nil Rate Band to their surviving spouse (called the Transferable Nil Rate Band). Their deceased spouse’s Nil Rate Band can then be used on their death in addition to their own Nil Rate Band. This will potentially give their spouse double the amount of Nil Rate Band to use when they die (currently this makes a total combined Nil Rate Band of £650,000).
The Residence Nil Rate Band
The Residence Nil Rate Band was formally introduced in 2017 by the Conservative government as a response to the ongoing criticism that the standard Nil Rate Band had not increased inline with the rapid increase in property prices. It also appeared to be introduced as a way to fulfil the Conservative’s election promise to raise the Nil Rate Band to £1 million pounds.
The Residence Nil Rate Band works by introducing an additional Nil Rate Band which can be claimed by executors or administrators of someone’s estate, providing certain criteria is met. The main criteria being, you need to leave a property to your lineal descendants. For the purposes of the Residence Nil Rate Band, the term ‘lineal descendants’ has quite a wide definition. Unlike the usual rules of succession this can include step-children, children adopted out of the family and even spouses of children or step-children. The Residence Nil Rate Band can also be transferred between spouses and civil partners in the same way as the Standard Nil Rate Band. This can effectively double the surviving spouse’s Residence Nil Rate Band allowance on their death (currently the Residence Nil Rate Band is £175,000) to £350,000 on the surviving spouse’s death.
But the Residence Nil Rate Band was a controversial introduction with suggestions that it was both over complicated and discriminatory. Unfortunately, people without property or children are unable to utilise the Residence Nil Rate Band, meaning that individuals could lose out on an additional £175,000 Inheritance Tax free amount, with cohabiting unmarried couples in this situation set to lose out on an additional £350,000 Inheritance Tax free amount.
Therefore, couples leaving property to children or other lineal descendants could utilise the Standard Nil Rate Band, the Residence Nil Rate Band as well as the Transferable Nil Rate Band and the Transferable Residence Nil Rate Band (clear as mud, right?) - which would effectively mean that married couples could have up to £1 million pounds before Inheritance Tax will need to be paid.
Gifting your cash
Any gifts you make during your lifetime or in your Will, could impact on how much of the Standard Nil Rate Band, the Residence Nil Rate Band as well as the Transferable Nil Rate Band and the Transferable Residence Nil Rate Band you have available.
The 7 year rule
All gifts between individuals are Potentially Exempt Transfers and so there is no Inheritance Tax payable at the time of the transfer, even if you gift more than the Standard Nil Rate Band. If you then survive 7 years, the transfer is then exempt for Inheritance Tax. However, if you were to die within the 7 years, then this gift becomes chargeable to Inheritance Tax. For example, you could give your son £500,000, and providing you survive 7 years, this will be free from Inheritance Tax and you still get to keep your Nil Rate Band. Any transfers into Trust are Chargeable Lifetime Transfers and will be an immediately chargeable transfer and will decrease the amount of Nil Rate Band available when you die.
Gift with Reservation of Benefit Rules
Don't tell me, Jack down the pub told you that if you give your house to your children whilst your alive, you can continue living there, no questions asked! Sadly, this is a misconception that we hear a lot. If you give an asset away, but you retain a benefit in that asset, then this will be ineffective for Inheritance Tax purposes and so will be taxable as part of your estate when you die.
Use your exemptions and allowances
Each year you are allowed to make gifts which are exempt from Inheritance Tax. Over time, you can use these exempt gifts to move substantial sums out of your estate and as such reduce any Inheritance Tax liability. Any gift exceeding your annual allowance will be treated as a Potentially Exempt Transfer.
Lifetime Exemptions
You get an annual exemption of gifts of £3,000. It is possible to roll over the previous year annual exemption too, if this was not used.
Single gifts of £250 to as many people as you wish.
Gifts out of income which you can prove does not impact on your normal standard of living.
Celebration of marriage gifts or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, or £5,000 for a child).
Payments to help with another person’s living costs, such as an elderly relative or a child under 18
Any gifts between spouses or civil partners, as long as they live in the UK permanently.
Gifts to charities, qualifying political parties and national bodies, such as museums.
Exemptions Available Upon Death
Any gifts between spouses or civil partners, as long as they live in the UK permanently.
Gifts to charities, qualifying political parties and national bodies, such as museums.
Estate Planning works for other taxes too
Whereas the intention when tax planning through Wills is to limit the amount of Inheritance Tax payable on a death, the intention of lifetime estate planning is often as much concerned with avoiding Capital Gains Tax or minimising an Income Tax bill as it is with Inheritance Tax. Because of the interaction of the taxes, you might sometimes have to accept a small Capital Gains Tax bill as part of the cost of avoiding a large Inheritance Tax bill, or a potential Inheritance Tax charge for a considerable saving of Capital Gains Tax. So you may have to accept that the payment of some tax (whether during the lifetime or on death) in order to ensure the best practical financial arrangements for the family.
It may not always be possible to achieve both objectives of financial security and tax saving and, so tax savings should not be attempted at the expense of financial security. With so many options available in creating a comprehensive estate plan, it can quickly become overwhelming. However, with the proper guidance, your estate plan can be easily crafted to fit your needs while giving you peace of mind. Talk to us today, we can help.
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