12 Inheritance Tax pitfalls
Inheritance Tax (IHT) is a tax that is paid on someone’s assets when they die. At its most basic, IHT is charged at 0% on the first £325,000 of your assets, and at 40% on your assets above that.
It can be a complex area, with many rules, exceptions, reliefs and rates. This article highlights 12 pitfalls to avoid so that your estate will not unwittingly pay more IHT than it should.
- Don’t presume that Inheritance Tax law has kept up with modern living
Many couples do not realise that only married couples/Civil Partners can pass assets between them without any IHT to pay. For an unmarried couple, if the first person to die leaves much of their estate to their partner, 40% IHT will be payable on the assets above the first £325,000. This is particularly unfortunate if the family home is the most valuable asset and IHT is payable, with insufficient cash in the estate to pay it. The surviving partner could have to foot the bill if they wish to continue living in the family home.
To avoid this, it is best to plan how to minimise the IHT payable on your death, and also to plan in advance how IHT will be paid. We can assist with this.
- Don’t scupper your efforts to gift assets away
Generally, if you gift an asset away and survive the gift by 7 years then it is no longer considered to be part of your estate for IHT. This is known as a Potentially Exempt Transfer (PET). A successful PET is a great way of saving IHT, as you can give away substantial assets to reduce the IHT payable on your deaths significantly or even completely. However, PETs are subject to strict rules. If you make a PET and you retain any sort of benefit to the asset (i.e. you give a house away, but continue living there without paying a full market rent to the new owner) then the PET can fail, and your estate will pay IHT on the asset. It is best to take advice on how to make a PET successfully and how to avoid falling foul of the rules.
- Don’t hold on to assets unnecessarily
If you have an asset that you don’t need and you plan on giving it to someone on your death, why not give it to them now? Gifting the asset now will mean that in 7 years the asset will no longer be part of your estate for IHT. If you wait until death to pass the asset on, IHT at 40% could be payable.
- Don’t contribute to someone else’s IHT problem unnecessarily
If you plan on giving assets to those who are already facing an IHT problem of their own, it could be better to leave your assets to someone else or consider the use of trusts to offer flexibility.
- Don’t let your surplus income become a large IHT bill
If you have more income coming in than expenditure going out, it can build up over time with potentially a large sum of IHT to pay on it on your death. However, it is possible to gift surplus income, so that no IHT is payable on it, and you do not even need to survive the gifts by 7 years. Various rules apply though, for which you should take advice.
- Don’t unwittingly lose the benefit of IHT exempt assets
Certain assets are exempt from IHT, such as some business assets and investments/schemes that are covered by Business Relief, and agricultural land eligible for Agricultural Property Relief. Without taking professional advice, you could unwittingly cash in an IHT exempt asset and replace it with cash/other assets which are not IHT exempt, without a good reason. This could cause some IHT to be payable on your estate, when it need not be. Taking appropriate advice can ensure that you make the best investment decisions and, where appropriate, preserve or invest in those assets which are IHT exempt.
- Don’t miss out on putting Life Insurance into trust if possible/appropriate
You may decide to take out life insurance to help your loved ones after your death. However, if the policy is set up to pay the proceeds to your estate, the funds could have 40% deducted from them in IHT. The life insurance can be set up in trust, so that any benefits can be separated from your estate. This can help with IHT planning.
- Don’t miss out on the Residence Nil Rate Band (RNRB)
If you plan on leaving your home to your descendants (including step or foster children) then it can potentially save your estate up to £70,000 in IHT if you are eligible for the RNRB. The rules on this are complex. If your estate is worth more than £2,250,000 then you may not be eligible for it, and you have to leave the property to your descendants in the right way in your Will. By taking appropriate advice when making your Will, we can help you secure the RNRB if it is available to you.
- Don’t miss out on the most IHT efficient way of giving to charity
Gifts made to charities are IHT exempt. If you are planning on leaving assets to charities in your Will, you will be pleased to know that the charities get the full benefit of the amounts that you give to them. However, if you gift at least 10% if your net estate to charity, your estate becomes entitled to pay IHT at 36%, rather than at 40%. Getting the figures right can make a big difference.
- Don’t leave IHT planning too late
It is easy to leave IHT planning to another day, as life can be busy with other more immediate demands taking up your time and attention. However, taking advantage of IHT planning early can ensure that you are doing everything you can to mitigate the IHT exposure.
- Don’t be a poor record keeper
Even if you have carried out the most careful and well thought out IHT planning, making gifts, passing on surplus income, and holding certain assets in the most efficient way possible – your efforts could come to naught if you have not kept accurate records and documented these efforts correctly. A lack of records, documentation and evidence could cause your executors to have an uphill battle with HMRC, proving what has been done. This could even lead to HMRC not accepting what has been done - meaning that IHT could become payable when it should not be. We can advise you on what to do.
- Don’t miss out on future developments or exemptions/reliefs that you do not know about
IHT and inheritance laws can change over time. To ensure that your estate is as IHT efficient as possible, it is important to keep up to date, which we can help you with.
Taking professional advice can help you to avoid the above pitfalls, and to make plans that benefit you, the people and causes that you care about, and minimise the IHT payable on your estate.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.