A Guide to Help Untangle Inheritance Tax
News updates relating to personal finance are hitting the headlines with more regularity especially topical and political headlines about pension’s freedoms, ISAs, Care fees and Inheritance Tax; most of which are still not widely understood. In the case of inheritance tax that’s worrying, because it affects thousands of families every year and some simple planning could save thousands of pounds for your family instead of going to the Revenue.
Modern inheritance tax dates back to 1894, when the government introduces ‘estate duty’ as a tax on the capital value of land.
Inheritance tax is not just for extremely wealthy people to worry about: rising property prices have meant more estates than ever are likely to face an inheritance tax bill. In fact, the amount of inheritance tax collected over the past five years has doubled, and the number of estates paying inheritance tax has nearly tripled over the same period.
In 2015/16 HM Revenue & Customs (HMRC) collected £4.7 billion from thousands of bereaved families.
If your estate has an inheritance tax liability, your beneficiaries will have to pay the inheritance tax bill; not necessarily the kind of legacy most people think of leaving behind.
The good news is that there are plenty of things you can do to take care of a potential inheritance tax problem. However, finding the right options for you will depend on your personal circumstances. In this guide, we set out some of your options in more detail to help you make an informed choice.
Estate planning can be complicated, although in many cases it doesn’t have to be. Talking to a Solicitor and a Financial Adviser about your situation can make a real difference. At TLP, we assist a great number of clients with the affairs of a deceased parent or spouse; our experience is that too many people are leaving their loved ones with a large and unnecessary tax bill to pay. The Law Practice Ltd have a dedicated probate department who alongside our recommended financial advisors can check your current will and financial situation and advise on the best way to leave your estate to your loved ones and at the same time make sure they benefit from the new inheritance tax based allowance.
The Basics of Inheritance Tax
Inheritance tax is paid on the value of the assets that a person leaves behind when they die. It can also apply to some gifts that are made before someone dies.
When you die, your ‘estate’ is the assets you leave behind
If you are married or have a civil partner, then you can leave your entire estate to your spouse or partner free of inheritance tax. However, if you want to leave some or all of your estate to other family and friends, then it may be liable for inheritance tax.
Who pays inheritance tax?
If the value of your estate is worth more than £325,000 (known as the ‘nil-rate band’), then HMRC will expect your Executors or Administrators to pay inheritance tax, at a rate of 40%, on the value of your estate over that amount.
Your estate can include:
- Your house and any other properties you own.
- Any savings or investments (some types of pensions are excluded, however other investments, including ISAs, are taxable).
- Any other assets.
- The value of any life insurance policies in your name.
The value of your assets is the total of all assets, this includes worldwide assets, so overseas bank accounts and property.
How to work out what your estate is worth
After adding up your assets, your next step should be to subtract any outstanding debts; these could include credit cards, loans and mortgages. You can also deduct the value of some gifts you may have made make during your lifetime, charity donations left in your will and reasonable costs for your funeral.
After calculating the value of your estate, is this potential value less than £325,000?
Should your estate be less than £325,000 then there is no inheritance tax bill right now. However, you should monitor the value of your assets, as any increases between now and when you die could mean your estate may breach the £325,000 Nil Rate Band and a potential inheritance tax bill.
Where the potential value of your estate exceeds £325,000 then your nil-rate band will be fully used up, and the remainder will be subject to inheritance tax.
Marriage and Inheritance Tax
Inheritance Tax rules differ depending on whether you are single, married or in civil partnership.
If you’re single and your estate is worth more than £325,000, anything over that amount will be liable for up to 40% inheritance tax.
If you are married, or in a civil partnership, the assets you leave to your spouse will be transferred without any inheritance tax to pay, and leaving assets to a spouse does not use up your nil-rate band.
If you pass on any of your estate to someone other than your spouse or civil partner, and your estate is valued at more than £325,000, then the excess will be subject to up to 40% inheritance tax (excludes gifts charities and political parties).
The estate of your surviving spouse, now widowed, will be subject to inheritance tax as outlined below.
When someone dies, their unused nil-rate band can be transferred to their spouse or civil partner.
For example, if your spouse left everything to you before they died, you could potentially have a combined nil-rate band of £650,000.
If you are part of an unmarried couple, you are still treated as single for inheritance tax purposes which means that each of you has a separate nil-rate band of £325,000 which cannot be combined upon death.
The current nil-rate band works so as when the first spouse or civil partner passes away they can leave their entire taxable estate to their surviving partner.
On the death of the surviving partner their estate can claim a total nil-rate band of £650,000 – double the individual nil-rate band.
In a similar way, the estate of the surviving spouse or civil partner to pass away will be entitled to claim double the residence nil-rate band applicable, in the year of the second death; providing their partner’s estate did not make such a claim. The maximum amount of claim will therefore be limited to;
- The greater of the allowance at the time of the home owned by the deceased.
- The value of the home owned by the deceased
The new residence nil-rate band
A new inheritance tax allowance was introduced in 2015. But the headlines that claim it will give people a £1 million nil-rate band needs to be understood and scrutinised closely.
Inheritance tax is a problem for homeowners
After years of rising house prices, more people are now facing an inheritance tax liability due to the increase in the value of their home. What’s more, the current nil-rate band of £325,000 for inheritance tax is expected to remain frozen until 2021.
In 2015, after acknowledging the inheritance tax problem faced by large numbers of homeowners, the Government introduced an additional inheritance tax allowance of up to £175,000. This additional allowance applies to the family home in certain circumstances. Even with this additional allowance, forecasts show that HMRC’s inheritance tax receipts are expected to continue to rise.
Introducing the residence nil-rate band
- The residence nil-rate band will apply to the estate of people who die after 6 April 2017.
- You must plan on leaving a residence to your children or grandchildren.
- It starts at £100,000 per person, increasing by £25,000 every April until 2020, when it will reach £175,000 per person (£350,000 per couple). Adding this to the couple’s nil-rate band equals £1 million per couple.
- From April 2021, it will increase in line with inflation every year.
Be aware; who can claim the new allowance?
The intention is that married couples and civil partners will eventually be able to pass on assets worth £1 million, including the family home, without paying any inheritance tax at all.
However, not everyone will benefit: there are a few rules you should be aware of:
- As the name suggests, this new allowance will apply where the person who has died owned a property that was at one time their home.
- It will also only apply if the property is being left to the deceased’s direct descendants (children or grandchildren). Gifts to a trust do not count as a direct descendant.
- It won’t help you if you don’t own a property, or if you don’t have direct descendants; or if you want to leave your home to someone other than a direct descendant.
- Property values less than £175,000 per person, or £350,000 per couple, will only partially benefit.
- Where an estate exceeds £2 million, the residence nil-rate band will be reduced by a rate of £1 for every £2 over the £2m value; this means that larger estates may not benefit from the new allowance.
- Anyone who disposed of their property before 8 July 2015 – for example, because they are in residential care or living with their children – will not benefit from the new allowance at all.
The new residence nil-rate band has been advertised and announced as allowing couples to claim £1 million of inheritance tax exemption. However, to do this, the following criteria have to be met:
- One spouse must pass away after 6 April 2020, when the £1 million maximum is reached.
- The surviving partner must own a home worth more than £350,000 when they die.
- They must leave that home to their children or grandchildren.
- Their total estate must be worth less than £2 million; likewise for their deceased spouse.
You may still be a little confused as to what applies to you and your situation. The first step is to get a financial review from our recommended team of financial advisors to establish IHT strategies to work alongside retirement and care fees planning. Things to consider are pensions as part of IHT and succession planning, and employ Equity Release as a supplement or additional income stream.
From here The Law Practice UK Ltd can review your Will. Remember, leaving your estate in trust does not count as a direct descendant so for those who have established a Discretionary Will Trust as part of their estate planning will need a solicitor to review what is currently in place.
Please call Katie Lawley at The Law Practice today for a confidential and no obligation discussion.