Saving tax on your estate

Broadly speaking if you have non pension assets in excess of £500,000, or £1 million as a married couple, you are likely to have an Inheritance Tax (IHT) Liability.

The easiest way to avoid paying IHT is to spend as much as you can while you’re alive. If you’ve got an IHT liability and you’re in two minds about that new car or big holiday, take 40% off the price tag and think of that as the Government’s contribution! If such frivolous spending doesn’t suit you, there are other ways of avoiding paying tax.

As with many areas of financial planning, starting early is a definite advantage. The next most straightforward method after spending capital is to give it away. In simple terms if you give capital to your children and live for seven years after the gift is made, they are entitled to keep the amount in full without paying any tax. However, you may have reservations about doing this, the most common of which is what if your now happily married children get divorced? This is where trust planning can become attractive.

Trusts add complexity but they can also increase flexibility and add protection to ensure the capital is only used in line with your intended wishes. Gifting to Trust has limits, although these are subject to the same seven-year rule meaning that starting early can mean more than one bite of the cherry.

Once capital is settled into Trust, the Trust becomes an entity in its own right and it has tax and investment considerations which you will need to address. Sometimes Trustees use an investment bond to hold Trust assets as this can remove the need for an annual tax return but it can also mean that annual capital gains and income tax allowances aren’t used so you will have to look at your wider circumstances and decide the best option for your Trust.

A Trust can distribute either capital and income, or both, but it will not be effective for IHT purposes if it distributes any benefit to the person who settled the money into it. If distributions are made, they may have tax implications on the person receiving the benefit. There is also a danger that an established pattern of distributions can be used as evidence of entitlement in divorce settlements, so care must be taken if this was an objective in setting up the Trust instead of simply making a direct gift. Sometimes people opt to take out an insurance policy, known as Term Assurance, that covers the tax liability that would be due if they die within the seven years.

Depending on the age of the person making the gift and their state of health, it is likely that the premiums will be significantly lower than paying the tax if they died within the period. You can also cover an IHT liability with a Whole of Life insurance policy that always pays out on your eventual death. It is essential that you structure life insurance correctly to ensure that it helps to pay for the tax burden rather than increasing it. So long as the premiums are paid from surplus regular income, they are usually exempt from consideration for IHT purposes. This is when you are allowed to avoid increasing your liability so regular income in excess of your expenditure can be gifted away.

The same principle can be used to make regular gifts directly, rather than as a premium to an insurance policy. There are certain circumstances in which you can make gifts of capital that are also excluded for IHT purposes. These include wedding or civil ceremony gifts of up to £1,000 per person, increasing to £2,500 for a grandchild or great-grandchild and £5,000 for a child. Gifts to charities, payments to help meet living costs or in any case you can give £3,000 per tax year. You can also make small gifts of up to £250 per person per tax year as long as the same person has not benefitted from any of the other exemptions. Although not a tax, many people also wish to avoid contributing excessive amounts towards their care at the end of life. The care fees system can be complex and there are differences in how different local authorities interpret and enforce the rules.

You are not allowed to deprive yourself of assets but certain steps can legitimately be taken to reduce risk and attempt to smooth out some areas of legislation that appear less fair. One example of this relates to your home. Two couples with exactly the same assets and health experiences could end up in entirely different circumstances, simply because of the order in which they need care.

If the first couple has one spouse needing care initially, with the second spouse remaining at home in their main residence and living longer than the spouse who needs care, they would likely retain the full value of the residence to pass down to the next generation. If the second couple experiences this the other way around, i.e. the healthy spouse dies first, leaving their share of the house to the spouse who needs care, the value of their residence could be depleted and may not be available to pass down.

Through careful planning and using Trust arrangements within your Wills, there are ways to ensure that you do not ever have to contribute more than your ‘share’ of the main residence.

Reasons for making a will

Find out why you should have a will, and the best ways to go about making one in this Which? guide

Inheritance Tax

Inheritance Tax (IHT) is paid when a person’s estate is worth more than £325,000 when they die – exemptions, passing on property. Sometimes known as death duties.

Deprivation of assets

The rules about care home funding and reducing your assets are complicated. Find out more information from Age UK.

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