Estate planning: Families could face an unexpected Inheritance Tax bill

Inheritance Tax

Do you know how much Inheritance Tax (IHT) may be due on your estate when you pass away? Research suggests that some could be leaving a bigger bill than they thought to loved ones.

As part of an effective estate planning process, it’s important to consider whether any IHT will be due. Often, there are ways you can reduce the bill or eliminate it entirely. These steps can ensure as much of your wealth as possible is passed on to family and friends, rather than the taxman. However, the first step needs to be understanding your IHT liability.

Canada Life’s IHT Monitor revealed four in five over-45s believe the current IHT rules are too complicated. The findings revealed there’s confusion over which assets are included in your estate for IHT purposes.

  • Half are unaware that savings held in an ISA are liable for IHT. While an ISA can be passed tax-free to a spouse or civil partner, if it’s passed on to anyone else it may incur tax.
  • Half are also unaware that their main property could be subject to IHT. The Residence Nil Rate Band does allow you to pass on more wealth free from IHT should you leave your main home to children or grandchildren. However, it may not cover the total value of your home.
  • 62% didn’t think pensions savings were subject to IHT. A pension can be an effective way to pass on wealth, but there are some circumstances where retirement savings will be included in IHT calculations.

The three above areas are likely to be some of your largest assets. Miscalculating what will be included in your estate when you pass away could mean your loved ones need to pay an unexpected IHT bill.

What is liable for Inheritance Tax?

When calculating IHT, your assets become known as your estate. This covers everything you own, from investments to property. First, you don’t pay any IHT on assets left to your spouse, civil partner, a charity, or a community amateur sports club. For others, the standard rate of IHT is 40%, however, the tax is only applied to wealth above certain thresholds.

Nil-Rate Band: The Nil-Rate Band is currently £325,000. If the total value of your estate is under this amount, no IHT will be due. If it’s above this figure, you may need to pay IHT on the portion that’s greater than £325,000.

Residence Nil-Rate Band: If you’re leaving your main home to children or grandchildren, your threshold can increase. If your entire estate is worth less than £2 million, the Residence Nil-Rate Band can add a further £150,000 to your threshold in 2019/20. This additional threshold will rise by a further £25,000 in 2020/21.

If you’re married or in a civil partnership, you can pass on any unused allowance from either the Nil-Rate Band or Residence Nil-Rate Band to your partner.

Discounting assets that are liable for IHT, such as savings in an ISA or your main home, due to a lack of awareness could mean a significant gap between the expected IHT bill and reality.

Reducing an Inheritance Tax bill

There are often steps that can be taken to reduce how much your loved ones will pay in IHT. However, the research also showed that many aren’t fully aware of the options open to them, including two popular methods.

Donating to charity: According to the research, just one in ten are aware that the amount of IHT paid can be reduced by donating to charity. People that leave at least 10% of their entire estate to good causes can reduce the IHT rate from 40% to 36%. Depending on the size of your estate, this reduced rate could have a significant impact on the amount that’s left to your loved ones overall.

Gifting: Giving away assets during your lifetime has two benefits. Firstly, you’ll be able to see the positive impact they have. Secondly, it can reduce the value of your estate, cutting the IHT bill in return. However, gifts may be considered part of your estate for IHT purposes for up to seven years. So, if you gift a lump sum to your children and die three years later, those gifts may still be included when calculating IHT.

However, there are gifts that are considered immediately outside of your estate. This includes gifting up to £3,000 per year, with the ability to carry forward a year. Despite the gifting allowance being a useful tool to reduce the amount of IHT paid, only 28% knew what the annual exemption rate they were entitled to was.

There are many other ways that IHT liability can be reduced. The most suitable approach will depend on your circumstances and priorities. If you’d like to understand if your estate may be liable for IHT or want to reduce the bill loved ones may face on their inheritance, please contact us.

Please note: Estate planning is not regulated by the Financial Conduct Authority (FCA). Levels of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.