Where do we want our money to go when we die? For many, this question will seem only appropriate in a future so distant that it’s utterly impossible to contextualise. For others, there are typically a few obvious answers; ‘to my family’, ‘to charity’ or, the more diplomatic; ‘it’s my money, I’ve earned it and I intend to spend every penny’.
The one answer I don’t tend to hear is; ‘in an ideal world, I’d like the government to take 40% off the top of my estate’. Yet without proper planning, this is the only scenario that I can absolutely guarantee for many individuals. The government want their share of the legacy you plan to leave to your loved ones.
In the 12 months to May 2017, the State collected its dues to the tune of £5.1bn in Inheritance Tax, a record figure that is only likely to rise in future. It’s a large debt that, sadly, many people do not consider until it’s too late.
Before we go on, some general housekeeping is required on this subject. Firstly, it’s important to understand that every individual has what is known as a ‘Nil Rate Band’ of £325,000. This is the amount of your estate that is exempt from Inheritance Tax, and any amount of unused Nil Rate Band can be passed onto your surviving spouse upon death.
It is not uncommon therefore, for an individual to end up with £650,000 in there estate that is exempt from the tax. Every penny above this though, is subject to a tax of 40%. The Nil Rate Band has been frozen at £325,000 per individual since 2010, despite the relentless rise in assets (particularly property and stock prices) since the turn of the last decade. It stands to reason then, that more and more people are being caught in the net of Inheritance Tax than ever before.
The government have, however, provided a little more breathing space for those who pass on their property on to ‘direct descendants’ as part of their inheritance, in the form of a ‘Residence Nil Rate Band’. This essentially provides a separate and additional Nil Rate Band on the property, at an amount of £125,000 per individual in the 2018/19 tax year. This is set to rise to an eventual figure of £175,000 by 2020/21, eventually resulting in a total Nil Rate Band per household of up to £1m for married couples.
There is, inevitably, a caveat to this, in that the Residence Nil Rate Band will be tapered off at a rate of £1 for every £2 of the net estate that is valued over £2m at the time of death. The lesson here; be careful not to build too much wealth – the tax man cometh!
Now of course, the old adage is that tax is a good problem to have – those with the most money pay the most tax. Yet wouldn’t it be nice to ensure more of our money is passed down to the people and causes closest to our heart after we leave this earth? Of course, the answer is yes, however a vast number of people are now being caught in the trap of inheritance tax, without knowing they have the power to do something about it.
Let’s look at some options:
First things first, make a will
On the face of it, a pretty obvious place to begin. Yet I have come across countless families who have neglected for so long, something so fundamental to having their affairs in order.
If you don’t make a will, your estate is subject to the mercy of whatever legislation exists at the time of your death. By making a will, you take control over your affairs and the speed with which this is dealt with, during a time of undoubted distress amongst the family. Imagine spending a lifetime building wealth and a legacy to leave to your loved ones, only to have no choice on whether the people and causes closest to your heart benefit from this. Absurd, right? Get it done.
Simple solution this one – gift money away from your estate while you’re still alive. Not only will this reduce the value of your estate that is subject to Inheritance Tax on death, it also has the added bonus of being able to see your loved ones enjoy their inheritance while you are still alive. Alternatively, you can gift away to a charity or cause close to your heart and live to see the difference made by your generosity.
It is important to realise however, that you must survive for at least 7 years after making the gift in order to it to fall outside of your estate completely. So, as long as you feel you are likely to live another 7 years, why not gift your inheritance while you’re alive? Not only will you see the impact it has on your family, friends and causes close to your heart, doing this will also reduce the tax eventually payable on your estate which further increases the inheritance you ultimately leave behind.
If you are concerned about giving money away only for your beneficiaries to waste it irresponsibly, there is a way to retain some control by gifting the money into a trust, of which you act as a trustee. The same 7 year rules apply, and there may be some tax to pay on the way in depending on the amount of the gift and the type of trust, however this does provide the opportunity to gift money to your family whilst retaining some control over the spending of it.
If you own ‘business property’ for a period of 2 years or more, and are still holding that property at the time of your death, the value of this is wholly exempt from IHT. Now, you don’t necessarily have to start your own business in order to benefit from this tax exemption. You could simply invest in one or more companies as a direct shareholder, and your money is subject to the same rules. As long as you on that stake at the time of your death, the value of your shareholding is completely free from inheritance tax (40%, remember).
If you favour a more diversified approach to your investing, professional investment companies run portfolios of AIM (Alternative Investment Market) shares, in which investors can spread their money across a wide range of different companies on the AIM list. AIM is a sub-market of the London Stock Exchange. It allows smaller, less-viable companies to float shares with a more flexible regulatory system than is applicable to the main market.
Of course, being smaller companies with lower liquidity than the big guns listed on the FTSE, these investments carry more risk than the conventional stocks and shares we’re perhaps more used to. Still, according to the London Stock Exchange; ‘AIM is the most successful growth market in the world’. If you can afford to take the risk with a proportion of your overall wealth, it can be a tremendous bonus to your financial planning. Oh, and any growth to the investment will also be exempt from IHT… happy days!
By arranging a Whole of Life insurance policy, you can simply pay a regular premium to protect against the IHT bill eventually due on your estate. This also has the side effect of reducing the value of your estate subject to IHT, via the premiums paid to the insurance company. The insurer will pay the sum assured upon death, which will cover the tax due on the estate, either in full or in part.
The vital thing here however, is to ensure that the policy is written in trust, preferably for the executors of your estate. The importance of this cannot be stressed too greatly; not only will the sum assured simply be payable to your estate otherwise, rendering the whole exercise ultimately pointless, the government expect the IHT bill to be paid before your estate can be passed down to your beneficiaries.
This can leave many people between a rock and a hard place; where an IHT bill is due yet they’re relying on the inheritance as the means to pay it. The only option here, I’m afraid, is to seek a loan to pay the Inheritance Tax. Want to avoid this? Ensure your life assurance is written in trust for your executors. Simple really, but so easily neglected.
Since the liberation of pensions announced in the UK in 2015, they have become incredibly effective in keeping a large chunk of an individual’s assets outside of their estate for inheritance tax purposes. Since pensions are generally set up under a trust, they are ring-fenced outside your estate and paid directly to your nominated beneficiaries upon death – therefore, these benefits can be paid before your executors are granted probate by the courts.
Better still, if an individual dies before the age of 75, there is NO TAX to pay on pension assets, regardless of who receives your fund. Die after 75 however, and tax is paid at the recipient’s marginal rate of tax. These benefits also remain wrapped up within a pension drawdown arrangement until they are paid out, so the funds will continue to benefit from tax-free growth so long as they remain invested.
If your personal estate (your home, your things, your cash and investments) is valued under £325k, you essentially have nothing to worry about.
If it is however, or likely to be in the future, it might be worth considering the above steps and contacting your adviser for a discussion.