Taking preventative action is essential
With careful planning and professional financial advice, it is possible to take preventative action to either reduce your beneficiaries’ potential Inheritance Tax bill or mitigate it out altogether.
1. Make a Will
A vital element of effective estate planning is to make a Will – unfortunately, a significant number of adults with children under 18 fail to do so. This is mainly due to apathy, but also a result of the fact that many of us are uncomfortable talking about issues surrounding our death. Making a Will ensures your assets are distributed in accordance with your wishes.
This is particularly important if you have a spouse or partner, as there is no Inheritance Tax payable between the two of you, but there could be tax payable if you die intestate – without a Will – and assets end up going to other relatives.
2. Make allowable gifts
You can give cash or gifts worth up to £3,000 in total each tax year, and these will be exempt from Inheritance Tax when you die.
You can carry forward any unused part of the £3,000 exemption to the following year, but then you must use it or lose it.
Parents can give cash or gifts worth up to £5,000 when a child gets married, grandparents up to £2,500 and anyone else up to £1,000. Small gifts of up to £250 a year can also be made to as many people as you like.
3. Give away assets
Parents are increasingly providing children with funds to help them buy their own home. This can be done through a gift, and, provided the parents survive for seven years after making it, the money automatically ends up outside their estate for Inheritance Tax calculations – irrespective of size.
4. Make use of trusts
Assets can be put in trust, thereby no longer forming part of the estate. There are many types of trust available, and they usually involve parents (called ‘settlors’) investing a sum of money into a trust. The trust has to be set up with trustees – a suggested minimum of two – whose role is to ensure that on the death of the settlors, the investment is paid out according to the settlors’ wishes. In most cases, this will be to children
The most widely used trust is a ‘discretionary’ trust, which can be set up in a way that the settlors (parents) still have access to income or parts of the capital.
It can seem daunting to put money away in a trust, but they can be unwound in the event of a family crisis and monies returned to the settlors via the beneficiaries.
5. The income over expenditure rule
As well as putting lump sums into a trust, you can also make monthly contributions into certain savings or insurance policies and put them in trust.
The monthly contributions are potentially subject to Inheritance Tax, but, if you can prove that these payments are not compromising your standard of living, they are exempt.
In 2015, the Government announced a significant change to Individual Savings Account (ISA) inheritance rules – a change that has the potential to improve the situation of around 150,000 widows or widowers a year. Under the new rules, additional ISA subscriptions are now available to a surviving spouse or registered civil partner where the ISA holder passed away on or after
3 December 2014. This applies whether
or not they inherit the deceased’s ISA.
This comes in the form of an Additional Permitted Subscription (APS) ISA allowance (additional to their personal annual ISA), equal to the amount that was held in the ISA on the day the holder died. These changes mean that the APS ISA allowance is now available to their spouse or registered civil partner, even if they are not resident in the UK.
This APS can be invested in either stocks and shares or cash. If you stay with the same ISA provider as your spouse, you can invest the cash value in the investments available to you or use the assets that they held in their ISA as an ‘in specie’ subscription (a transfer of assets from one person to another without those assets being sold), assuming that you inherit those assets.
The additional allowance can also be transferred between ISA providers, but you will need to select from the new provider’s investment options (the in specie option will not be available). However, it is important to note that this additional allowance has to be used within a specific time limit.
Significantly, these allowances are available whether or not the surviving spouse or registered civil partner inherited the deceased’s ISA assets, so even if a spouse decides to bequeath the investments held within the ISA to an alternative beneficiary – perhaps passing them on directly to children or grandchildren in their Will – their surviving spouse will still benefit from the equivalent worth of tax-efficient savings potential.
6. Provide for the tax
If you are not in a position to take avoiding action, an alternative approach is to make provision for paying Inheritance Tax when it is due. The tax has to be paid within six months of death (interest is added after this time).
Because probate must be granted before any money can be released from an estate, the executor – usually a son or daughter – may have to borrow money or use their own funds to pay the Inheritance Tax bill.
This is where life assurance policies written into an appropriate trust come into their own. A life assurance policy is taken out on both a husband’s and wife’s life, with the proceeds payable only on second death.
The amount of cover should be equal to the expected Inheritance Tax liability. By putting the policy into an appropriate trust, it means it does not form part of the estate.
The proceeds can then be used to pay any Inheritance Tax bill without the need for the executors to borrow.