The unpredictability of life is a fact humanity must face. Another fact is that life inevitably comes to an end. When that happens, the shock and sadness of losing a loved one are the first things we experience. But the truth is that, as the days go by, a task becomes necessary regardless of how we feel—managing the deceased's inheritance.
This is not an easy task, and good planning can greatly help the family get through this delicate moment with as little disruption as possible. This planning should include, among other things, the impact of taxes on the inheritance and ways to protect the estate from these charges. Learn more about what this means.
What is Inheritance Tax?
Inheritance Tax (IHT) is a tax on the assets of someone who has passed away. In the UK, it is levied on the value of an estate that exceeds a set threshold, known as the nil-rate band, which is currently set at £325,000.
The standard inheritance tax rate is 40%. This means the heirs must pay the state the equivalent of 40% of the amount inherited above the threshold. However, this only applies to the portion of the estate that exceeds the nil-rate band. This is commonly referred to as the IHT threshold.
If the entirety of an estate is left to a spouse, civil partner, charity, or community amateur sports club, it will be exempt from inheritance tax. This means no IHT is payable by the beneficiaries, even if the value of the assets exceeds the £325,000 threshold.
In addition to the standard nil-rate band, there is an extra residence nil-rate band, which is up to £175,000. This is available when the family home is passed on to direct descendants (children, grandchildren, etc.).
How To Protect Your Estate Against Inheritance Tax
Minimising inheritance tax requires careful planning and making use of the available allowances, reliefs, and strategies. Below are several key methods to reduce or eliminate IHT liability on an estate:
Use of Nil-Rate Band and Residence Nil-Rate Band
Every individual has a nil-rate band of £325,000, which is the amount of the estate exempt from inheritance tax. If your assets are valued below this, no IHT is due.
You can also benefit from the residence nil-rate band, which provides up to an additional £175,000 if you pass your main home to direct descendants (children or grandchildren). For couples, combining these allowances can increase the total tax-free threshold to £1 million.
Gifting During Your Lifetime
Gifts made more than seven years before your death are exempt from IHT. This is known as the seven-year rule. If you survive for at least seven years after making the gift, it will not be included in your estate for inheritance tax purposes.
You can give away up to £3,000 each year as part of your annual gift allowance, without it being subject to IHT. Unused allowance can be carried over for one year, potentially allowing you to give £6,000 tax-free.
Smaller gifts of up to £250 per person per year are also exempt, and there are specific allowances for wedding or civil partnership gifts.
Trusts
Setting up a trust can reduce the value of your taxable estate. By transferring assets into a trust, those assets are no longer considered part of your wealth, reducing IHT liability.
Different types of trusts, such as discretionary trusts or bare trusts, have varying tax rules, and it’s important to choose the right structure based on your needs. Trusts can also help in controlling how and when your beneficiaries receive their inheritance.
Leave Money to Charity
If you leave 10% or more of your assets to charity, the rate of inheritance tax on the rest of your estate is reduced from 40% to 36%.
Business and Agricultural Relief
If you own a business or agricultural property, you may qualify for Business Relief or Agricultural Relief, which can reduce or eliminate inheritance tax on those assets. Business Relief can provide up to 100% exemption for qualifying businesses or shares in an unlisted company, while Agricultural Relief applies to farmland and agricultural property.
Use of Spousal Exemptions
Transfers between spouses or civil partners are exempt from IHT. You can pass on your entire estate to your spouse without paying any inheritance tax. As a result, the deceased person’s £325,000 nil-rate band goes unused.
When the surviving spouse or civil partner dies, they can add the unused £325,000 nil-rate band from their partner to their own, effectively doubling their IHT-free threshold to £650,000.
Seek Professional Advice
Inheritance tax planning can be complex, and the rules can change over time. Consulting Liverpool Wills solicitors is crucial to ensure you are making the most of the available exemptions and reliefs, and to avoid unintended consequences.
By using these strategies, you can effectively reduce the inheritance tax burden on your estate and ensure that more of your wealth is passed on to the people you love.
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