More and more of us are now likely to be caught by Inheritance Tax (IHT), mainly due to house price rises and frozen tax allowances. In ten years’ time UK taxpayers will be paying a staggering £11 billion in IHT. Following our recent webinar, Peter Webb, Head of Tax Advisory, explores the proactive tax and estate planning steps which you can take to safeguard your wealth for the next generation.
IHT is a thorny subject. Ultimately it involves your estate – at the point of your death – being taxed. Given that you’ll already have paid Income Tax and Capital Gains Tax on the wealth you’ve built, it’s no surprise that IHT can be compared to paying tax on top of tax. At 40%, IHT can be a significant concern now affecting more people than ever before. It’s therefore important to consider who you want to inherit your wealth, and how to pass it on in the most tax-efficient way.
Understanding if IHT will catch you and your family
The first step when IHT planning is to look at what IHT looks like for you and your family. There are a few essentials to bear in mind:
- Know your domicile – your domicile determines which assets will be caught for IHT so understanding your status will help you know if you’re exposed. If you’re non-UK domiciled your worldwide assets may be out of the IHT net, but your UK assets may suffer.
- Calculate your IHT bill – understanding what you (or your beneficiaries) exposure might be is a useful exercise and helps you better appreciate what might need to be paid. Don’t forget the current exemption which sits at just £325,000, and remember that this exemption hasn’t risen since 2010 and is set to remain frozen at this level until at least 2028.
- Check your Will – make sure your Will specifies your beneficiaries and is written tax efficiently – don’t assume your spouse or partner will automatically inherit.
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Simple ways you can reduce your IHT bill
Peter Webb, our Head of Tax Advisory, looked at some of the ways to reduce IHT:
- Spend it – this is as simple as it sounds! If you spend your wealth the value of your estate will drop, and your associated IHT bill will reduce too.
- Gift it – there are a number of ways to make gifts through your life, but you do need to bear in mind the seven year rule – generally you need to survive for seven years to eliminate IHT completely. One of the most helpful options is to make gifts out of your regular income or normal spending. These payments are immediately exempt although it’s important to keep good records. If you are making outright gifts there are options to use a Trust too. What’s imperative is not to make a significant gift without thinking about the long-term consequences. If you gift the family home to your child for IHT reasons, and you child then divorces the home may then fall into the divorce settlement and be lost from the family.
- Use allowances – every year there are a number of options to pass on wealth through an annual allowance of £3,000, on a small gift allowance of £250, and gifts on marriage of up to £5,000.
- Investing – using pensions and other IHT friendly investments can help ringfence your wealth away from IHT.
- Insuring – there are a variety of ways where insurance can help mitigate IHT.
The key steps to take to plan for IHT
Huw Wedlock, our Director in Singapore, shared how important it is to plan ahead, even if you then decide it’s better to take no other action. Ultimately what’s important is working out whether you do want to try to avoid IHT, and your appetite to do so. Your strategy for safeguarding your wealth is likely to be individual to you and your family, and involve a mixture of spending, gifting, allowances and investing. What’s important will be to create that plan, and then check progress along the way.
Huw also noted that many parents are concerned about the effect of passing on wealth to their children, wanting them to grow up as well-adjusted individuals without reliance on a family inheritance. For this reason many families leave those conversations until their children are in their 20’s – which could be too late. Trust planning can be particularly relevant here – offering the opportunity to shelter assets but with the Trust in control. And with Trusts being able to take control of assets for many years if needed this can be a good option.
The right time to start passing on your wealth
Shannon Brightman, our Chartered Legal Executive, touched on a few key areas to consider:
- Create a Will – the importance of an up-to-date Will can’t be overlooked. If you don’t have a Will you have no say over who inherits!
- Share your plans – talking about your plans is key. Be open and honest and appreciate that conversations may be emotional, but they are important to have to avoid leaving conflict behind. So conversations about wealth can be managed even with young children to reassure them that you have people in place who will help if something happens to you. As children grow up you can have more frank conversations about plans for your wealth. Obviously these will be very individual conversations which depend on your family dynamic and circumstances.
- Use professionals – they can help facilitate conversations with a more objective view and some emotional distance.
- Know your beneficiaries – if you are gifting or leaving wealth during your lifetime, think clearly about the right time to pass it on. Your child or the person you’re gifting to could thrive with a financial gift, or find it a burden. If you have beneficiaries who you plan to pass on significant wealth too, especially if you plan to gift it through your life, it’s usually better to talk things through so that the inheritance is expected and respected.
The panel also repeated how important it is to take action. Leaving planning too late or assuming that doing nothing won’t cause problems for those you leave behind are common mistakes. And if you’re overseas you shouldn’t assume that being non-resident for many years will exclude you – your UK domicile can follow you for life!