No-one wants to pay more inheritance tax than they need to. With careful tax and estate planning it is usually possible to reduce – or even eliminate – tax liability. Inheritance tax is sometimes called ‘the voluntary tax’ for that reason. See our Guide to tax and estate planning, “What’s Your Legacy?”
Are Gifts To A Spouse/Partner Tax-Free?
Yes. What you leave in your will to your spouse or civil partner is currently free of tax.
The Nil Rate Band – Is It Transferable?
The nil rate band (NRB) is the sum you can gift which is taxed at 0%. It is currently £325,000. If your estate is valued at above this level, it is potentially taxed at 40%.
But if a spouse or civil partner does not use up their NRB with gifts to non-exempt beneficiaries, it can be transferred. Any percentage remaining can be transferred to the surviving spouse or civil partner. This will often apply where a couple leave their estates to each other. The transfer of assets between spouses and civil partners (in lifetime or on death) is an exempt transfer. So no tax would be payable on the first death. On the second death the surviving spouse would have a NRB of £650,000 (£325,000 + £325,000).
For example, Mr and Mrs H have an estate worth £800,000 between them. Mr H dies leaving everything to Mrs H: the spouse/partner exemption applies, and so no tax is payable on his estate. His NRB also passes to Mrs H. When she dies, she has a NRB of £650,000, and so tax is payable only on the balance of £150,000 at 40%, i.e. £60,000.
There is more good news. An additional NRB of £175,000 (in the 2020-21 tax year) is available for residential homes left to a direct descendant, e.g. a child or grandchild. That can also be passed to a surviving spouse/civil partner, giving a total of £350,000. This means that couples who own their own home may not have to pay any inheritance tax if their combined estates are less than £1,000,000 (£650,000 + £350,000).
Reducing Tax Liability Through Estate Planning
Tax and estate planning is important if you have assets above the NRB (£325,000). If you are not married, tax of 40% will be payable on that amount above the limit. Some tax planning make sense.
One common way to reduce the value of an estate is simply to give it away in small chunks during your lifetime. Obviously, you need to take care not to give away more than you can afford, or leave yourself unable to live. You are currently able to give away £3,000 every tax year without any liability to inheritance tax. If you give away more than this, then that amount above £3,000 could be added to your estate for calculating tax. However after 7 years, those payments are no longer included in your estate, no matter how large.
You are also allowed to make unlimited gifts out of surplus income. Paying for a grandchild’s school fees is a common means of doing this. Again, you need to take care that the gifts do not affect your lifestyle, otherwise the exemption is lost. It is wise to keep good records of such payments.
Changing The Terms Of A Will (After Death)
Where someone inherits a gift (or even a whole estate) late in life, they often find that they do not really need the money. Other family members might need it more, such as children or grandchildren. If you are in that situation and simply give the money away, then your own estate would potentially have to pay tax on that. A more tax-efficient method is to vary the will, which can be achieved with a deed of variation.
For example, Mrs A inherits her mother’s entire estate. She is already established in life and does not need the money, whereas it would really benefit her children. She makes a deed of variation so that the effect of her mother’s will is to give the estate to the children. There is then no impact on Mrs A’s own estate in due course.
Setting Up A Trust As Part Of Estate Planning
A trust is way of managing money (or other assets including property) for people. A trust allows a trustee (such as a family member, lawyer, banker, etc.) to hold assets on behalf of beneficiaries. They can be used to protect family assets, and provide for minors or vulnerable individuals. They can also be used for tax planning purposes, i.e. to reduce the tax payable on an estate.
You need to consider carefully how a trust is structured and set up. There can be capital gains and income tax implications. However, with suitable planning these can be limited if not avoided altogether. There is also a potential inheritance tax charge, as well as anniversary charges every 10 years and charges when capital is paid out to beneficiaries. Again, careful planning should mean that these are minimised. Trusts can be an important part of your tax and estate planning strategy.
Protecting Family Wealth
People are often concerned about leaving gifts in their will to family members who are vulnerable or whose relationship is in trouble. Will a particular beneficiary use their inheritance wisely? Could it end up outside the family post-divorce?
One solution is to use a discretionary trust. This is a very flexible way of leaving assets where there is uncertainty about future events. The trust has a group of potential beneficiaries but none of them is entitled to any defined share in the trust fund. They just have a hope of benefiting. The trustees (who will usually also be the executors of your will) decide who receives what and when. You are able to provide guidance to the trustees by a ‘letter of wishes’ as to how you would like them to exercise their discretion.
It is important (for tax reasons) that the trustees are not bound to follow your letter of wishes. They must exercise their own discretion while taking into account your expressed views. So the trustees have to be chosen carefully, and you must trust them completely.
For example, Mrs W is a widow with no children and wishes to leave her estate to her adult niece and nephew. Unfortunately, her niece has a history of drug problems and her nephew is going through a rocky patch in his marriage. Mrs W is concerned. If the estate goes to her niece it would feed her drug habit. If it goes to her nephew some of it might go to his wife on a divorce. A solution for Mrs W is to leave her estate on a discretionary trust. The beneficiaries would be her niece and nephew. Her trustees can then assess the situation at the time, rather than Mrs W trying to predict the future before her death.
Business And Agricultural Reliefs
Two important tax reliefs are business relief (BR) and agricultural relief (AR). Where available, they mean that no tax is payable on the value of a business and of farmland in an estate.
BR is available at 100% for an interest in a business. It can be as a sole owner, a partnership or a limited company. It is based on the whole value of the share in the business less any liabilities, rather than on the value of individual assets. However the relief is reduced to 50% for any assets (such as premises) used by the business.
AR is available at 100% on the agricultural value of farmland and farm buildings to a working farmer. It is also available where farmland is owned by an investor (rather than a farmer) if it has been owned for 7 years.
It is important to take advice about a particular set of circumstances. Call us today to discuss your situation and how we can help.
Want To Know More?
See our guide to Guide to tax and estate planning, “What’s Your Legacy?”
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