Most of us are aware of the potentially devastating consequences of leaving loved one’s without any workable plan in place for the period that follows a death, but how to plan against those issues is a little less clear.
The most obvious way to avoid setbacks and complications is to create a will. There are, of course, some caveats – namely, the fact that, to an inexpert eye, a legally valid will and an invalid will can look very similar, meaning ‘DIY wills’ pose a serious risk for the future.
But, provided you work with a professional to plan your estate, the risk is minimised. What’s more, during this process it is very likely that other, related measures – measures designed to bring the most benefit to your loved ones – will be brought to the table, including inheritance tax planning.
What is inheritance tax?
A tax imposed by the government on the estates valued above the current threshold of £325,000. This tax is only applied to the amount exceeding the threshold – so, for an estate valued at £600,000, £275,000 would be taxable.
The standard rate of inheritance tax is 40%, meaning families could miss out on a very significant portion of an estate, unless that estate has been subject to full and thorough inheritance tax planning.
Under some circumstances, an inheritance exceeding the threshold won’t be taxed. Assets inherited by spouses and civil partners are not taxed, and neither are bequeathments made to charities or certain clubs. To circumvent the tax entirely, however, everything in your estate that exceeds the threshold would need to be left to these entities.
You can take a look at our full guide to inheritance tax for more information on the subject.
What is Inheritance Tax Planning?
Under the remit of estate planning, inheritance tax planning is the process of optimising your loved one’s future inheritance against a dauntingly high rate of inheritance tax. While you cannot sidestep it entirely, you can restructure your estate so that it is subjected to a lower rate – thus leaving your family more of what you’ve worked to give them.
When the question of estate planning arises, it can be tempting to take what appears to be the path of least resistance – that is, for most of us, not putting a plan in place and simply letting our closest relative (a spouse or child, for instance) inherit the entirety of our estate without any other wishes or caveats.
In the overwhelming majority of cases, however, this proves to be a monumental mistake, since estate planning is about much more than simply deciding who will inherit what from your estate. You need to be careful and intentional, or your wishes may be overridden by taxation and legal restrictions.
A healthy estate is one that is prepared. A high inheritance tax is relatively easily avoided, but all too often encountered only when it is too late. Unless the entire value of your estate sits below £325,000, then you should consider it to be sufficiently ‘complex’ that it needs to be primed against inheritance tax.
How Can You Avoid Inheritance Tax?
Ultimately, if your estate’s value is high enough to be taxed and you want to leave it to anyone other than a spouse or charity, you won’t be able to avoid inheritance tax entirely – and waiting until the last moment to gift large sums of money to your loved ones is not the answer. A comprehensive, long-term approach to minimising the impact of tax on your family’s inheritance is the only effective way to manage your estate against it.
One of the best ways to do this is to create trusts. Under certain circumstances, money housed in a trust will no longer be considered as part of your estate (and therefore no longer taxed), and you can make certain stipulations that prevent the trustee from gaining access to that money sooner than you would like. This is not always the case but, with the right conditions, these funds can be protected from inheritance tax.
Many people also choose to give gifts to family and friends in relatively small increments over the years, so that they can benefit from lump sums over a longer period of time, free from inheritance tax. You can give away up to £3,000 each year without the risk of it being taxed at a later date, and £5,000 if one of your loved ones gets married. Gifts that fall outside of these requirements will need to be survived for seven years, so they’re not always ideal.
As mentioned above, charitable donations are not subjected to inheritance tax. So, if your estate exceeds the threshold by a relatively small amount, and the 40% tax reduces it to a nominal amount, you may feel happier leaving that sum to charity. Even if you only donate a percentage of that excess amount to charity, charitable donations can reduce your inheritance tax rate below 40% — another great way to ensure your family get a little more.
There are many, many different options for reducing the inheritance tax your family will be left to wrestle with, but the right combination of factors is a personal matter – and something that Fingerprint Financial Planning is perfectly placed to offer advice on.
What is the 7-year rule in inheritance tax?
When a person chooses to gift money (beyond the tax-free £3,000 a year) or ownership of a property directly to a loved one – or, alternatively, via a trust that will be accessible at some point in the future – the key to avoiding inheritance tax further down the line is to ‘survive’ the gift for seven years.
Ultimately, this means that a gift of this nature made within seven years of the gift-givers death will be taxed after they have passed away.
For obvious reasons, this makes inheritance tax planning more complicated the more time that goes by, and the older we get. It’s far better to start preparing the estate against tax before it starts to feel like a race against the clock.
At Fingerprint Financial Planning, our expertise lies in anticipating the best and worst case scenarios for our clients, and in ensuring that they are consistently working toward the ideal outcome for themselves, and their loved ones. Preparing your finances is a lifelong process, and we are able to offer expert, independent advice every step of the way. Get in touch with us today to find out how we can help you.