What is Inheritance Tax in the UK?
Are you confused about inheritance tax planning in the UK? It can be a complex subject and daunting, but navigating this complex process is possible.
Inheritance tax is a topic that most people don’t like to consider. But it’s essential to understand how it works and how you can minimise it.
For many people, giving part of your estate to the government as tax is unpleasant.
In this post, we’ll explain everything you need about inheritance tax planning. We provide practical tips to give you the basic knowledge.
Who is Liable to Pay Inheritance Tax?
If someone inherits assets, they might need to pay inheritance tax. The tax will be paid before the inheritance is distributed. Tax due must be paid within six months after the person has died.
Executors of the estate are required to calculate the tax IHT is different to to income tax.
IHT is paid before a grant of probate is issued. This duty falls on those administering the estate. They must file an IHT return with HM Revenue and Customs (HMRC).
If the estate includes a trust, the trustees of this trust are responsible. The trustees are responsible for caring for the trust. They need to ensure that inheritance tax is paid on time.
UK HM Revenue & Customs reports on the amount of IHT. The amount of (IHT) paid per estate has varied over the last few years.
In the 2018/2019 tax year, the average Inheritance Tax Charges IHT paid was around £182,000. This is only an average. The amount may differ depending on the situation.
How does Inheritance tax work?
Inheritance tax will apply to estates over a certain amount. You are eligible for relief before tax. These reliefs can change depending on your situation.
The main reliefs are the nil rate band and residents’ nil rate band. Any estate below the value is exempt from IHT. Estates over the amounts are liable to tax at 40%. The tax is applied to assets over the allowances.
From 2019 to 2020, the number of estates that paid IHT was 23,000 in the UK. This was 900 more (equivalent to a 4% rise) than the previous year.
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Gift Exemptions and Reliefs
The UK has a “nil-rate band” of £325,000 per eligible person. This amount of your estate is exempt from inheritance tax (IHT). The remaining part is the taxable estate.
For married couples, the threshold is doubled to £650,000. This is because you can transfer the nil rate band between spouses. This is an easy way to reduce your inheritance tax bill.
The residence nil-rate band (RNRB) is an additional nil-rate band. It applies if you own or have owned your main home. Specific qualifying rules apply to be eligible. The RNRB is £175,000 for each eligible person.
It has remained at this level for several years. The allowance is transferable between spouses and civil partners.
You have the option to give gifts to your loved ones during your lifetime. These gifts may be exempt from IHTdepending on the size.
The annual exemption/gift allowance is up to £3,000 per year. Other exemptions can reduce the IHT debt. These can include gifts for marriage, loved ones or charity.
Wills and Probate Law
Wills and probate law covers the managing of a person’s assets post-death. Specific important components of this legislation include.
A will is a legal document. It describes how a person’s assets should be dealt with on death.
To be valid, the testator must sign a will. It should be witnessed by two people who are not beneficiaries of the will. It can include instructions the executors should follow.
If someone dies without a will, specific rules apply. The law is the rule of intestacy. Particular rules apply to the distribution of the estate. The rules specify which relatives will receive a portion of the estate.
This will include spouses, children, parents, and other close relatives.
Executors are appointed to manage the deceased’s estate. They will pay debts and taxes and distribute assets to beneficiaries. They are required to ensure the estate is handled correctly.
Probate is a legal process proving the validity of a will. Executors obtain a legal document called the Grant of Probate. It allows the executor to administer the estate. Probate is required when the estate exceeds a particular value.
How to Reduce Your UK Inheritance Tax Liability.
To reduce the tax, you could use these inheritance tax planning tips:
Using your annual gift allowance is a starting point. Any gifts within the exemption are tax-free. We recommend you get advice if you want to make more significant gifts.
Different rules depending on the size and the person receiving the gift. Tax treatment will vary. This depends on the gift and who receives it.
It could be a potentially exempt transfer PET (7-year rule). Or, if it is over the nil rate band, a chargeable lifetime transfer.
Consider putting Life Insurance in Trust.
A whole life plan in trust could be beneficial. The plan pays out the proceeds outside your estate for IHT purposes.
Use Trusts for Estate Planning.
Certain trusts can be used to reduce your estate’s liability to IHT. We cover a few of the basic trusts later in the post.
Invest in Assets that do not incur Inheritance Tax.
Certain types of investments can be exempt from inheritance tax. There will be a period you need to have held the investment. This is a specialist we can help you with.
One way to reduce your estate IHT bill is to spend more.
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Trusts and Inheritance Tax Planning
Inheritance tax planning trusts can be helpful when planning. They can help to reduce the amount of tax your estate might pay.
The amount paid into the trust will count as a gift, and current gifting rules apply. If the gift is a Potentially Exempt Transfer PET, then the 7 year rule would apply. The sliding scale will come into play if the donor has died within 7 years. Different rules apply for Chargeable lifetime transfers.
Several types of trusts can be helpful in estate planning. Each has its advantages and drawbacks.
Discretionary trusts, or family trusts.
This type of trust is a popular estate planning tool. They have more flexibility than Bare Trusts. Discretionary Trusts can be more complicated to administer. They can help manage assets and protect your beneficiaries.
Bare trusts are the simplest type of trust. The trustee has no discretion when benefits are distributed. The beneficiaries will receive the proceeds from the trust. These types of trust are used to make outright gifts.
Discounted gift trusts.
This trust allows you to transfer assets to your beneficiaries. It will enable you to take an income. This can be helpful if you want to minimise taxes on your estate.
Gift and Loan trusts.
This trust allows you to lend an amount of money to the trust. Any growth on the loan is outside your estate. This can be helpful if you need access to the amount lent.
How to plan for inheritance tax
Balancing the benefits and implications of tax planning is complex. Especially so when dealing with Inheritance tax. You need to understand the pros and cons of this sort of tax planning.
It isn’t easy to retain control and shield an asset from IHT. A good rule in inheritance tax planning is to keep a balance. Most people will reduce the potential tax payable over several years.
Combining different strategies is the best approach. Your options can vary according to your situation. Ensuring you use the correct approach is essential.
Inheritance tax planning can be a daunting and confusing topic. If you want to find out more, we have produced a free IHT guide. A copy is available in the guides section of our site.
If you would like to discuss your situation, please contact us. Or, you can use the book an appointment button to arrange a meeting with our financial adviser.