Estate planning is a vital part of your financial plan. Many people don’t like to think about what happens when they are gone. But approached constructively, your Estate plan can help you preserve your legacy and leave a positive impact on the world.
You have worked hard to build up wealth over your lifetime. You should have some input into how the money is used, even when you cannot make the decisions yourself. Your financial plan should reflect your goals and values, both during your lifetime and beyond.
Inheritance Tax (IHT)
IHT may be payable on your estate when you die. This works as follows:
- You have a maximum nil rate band of £325,000. If your Estate is valued at less than this when you die, no IHT is payable.
- Married couples and civil partners can therefore effectively have a joint nil rate band of £650,000 on second death. This applies where the Estate is passed to the surviving spouse or civil partner. On first death, if assets pass to anyone else, this could use up some of the available nil rate band, depending on the assets concerned.
- If your Estate includes a property you have lived in at some point, you may also be able to claim the residence nil rate band (up to £175,000 per person). This is subject to certain conditions and is reduced for Estate values of over £2 million before reliefs.
- After deduction of the nil rate band, the residence nil rate band, and any other IHT reliefs such as Business property Relief, your residual Estate will be taxed at a headline rate of 40%.
Making gifts to your loved ones during your lifetime can help to reduce the value of your Estate. But it also means that you have the benefit of seeing them enjoy the money, without the added grief or stress than inevitably comes with an inheritance.
Gifts are also immediately excluded from the residence nil rate band calculation. Reducing your Estate under the £2 million threshold can increase the relief available.
Lifetime gifts are treated as follows for IHT purposes:
- You can give away up to £3,000 per year. This is immediately exempt from your Estate. The allowance can be carried forward by up to one tax year. A couple could therefore give away up to £12,000 this year within the exemption if they had not used last year’s exemptions yet.
- Other exemptions apply for smaller gifts as well as Christmas, birthday, and wedding presents.
- If you have a surplus income, you can also make regular gifts, providing these are affordable from genuine income, such as employment earnings, dividends, or pensions.
- If your gift does not qualify for these exemptions, it will be considered a Potentially Exempt Transfer (PET). This remains in your estate for seven years and will be added back into your Estate if you die within this period. Some measure of relief is given after three years however, where the gift triggers a liability to IHT.
Planning ahead is important when it comes to lifetime gifts. You should aim to strike a balance between reducing your Estate while ensuring that you have enough money to achieve your own goals.
Remember that if you lose capacity in the future and need to rely on a Power of Attorney, your appointed Attorney cannot make gifts for you with the intention of reducing IHT.
A Trust is a method of designating assets for one or more Beneficiaries without giving up full control. A Trust may be:
- Discretionary – this relies on the Trustees to make decisions over who receives income or capital from the Trust and when. They can be guided by the wishes of the Settlor (the person who originally set up the Trust).
- Life Interest – here one or more Life Tenants have an absolute entitlement to any income received by the Trust, with the capital being for the benefit of other Beneficiaries, usually once the life interests have come to an end.
- Bare/Absolute – here, the Trustees are simply holding the asset on behalf of someone who can’t hold it themselves. This type of Trust is usually set up for children, who will become fully entitled to the asset when they reach the age of majority.
Trusts can serve the following purposes:
- Setting aside assets for a particular Beneficiary or class of Beneficiary.
- Allowing one party to receive income whilst preserving the capital for another Beneficiary.
- Protecting specific assets from poor decisions, divorce, bankruptcy, or a loss of capacity on the part of the Beneficiary.
- Reducing the value of the Settlor’s Estate.
Trusts are complex and arranging gifts in this way can result in tax consequences. It’s important to seek advice on the best Trust option for you.
Making a Will
Making a Will can ensure that your Estate is distributed according to your wishes. Some of the benefits of having a Will are:
- You can appoint your own Executors. It is important to nominate people you trust to administer your estate.
- You can use your Will to make gifts of any value to anyone you choose, including family, friends, charities, and other organisations.
- Your Will can also be used to set up Trusts, which gives an additional element of control over how the assets are used. It also means that the assets will be outside the estate of your beneficiaries, potentially reducing their own IHT liability.
- By passing assets to anyone other than your spouse or civil partner (including into a Trust), this will use up some of your nil rate band. However, this allows the assets to grow in value outside of their Estate.
Combining Your Retirement Plan and Your Estate Plan
Retirement and Estate planning often go hand in hand. A good financial plan can help you ensure that your own lifestyle remains on track, while planning your legacy.
Pensions are not typically considered to be within your estate for IHT purposes, although this is not always the case. Your pension can be paid out to your Beneficiaries free of tax on death before age 75. On death after age 75, the Beneficiaries will pay tax at their marginal rate on any funds drawn from the pension fund.
It can be worthwhile to preserve your pension to pass on, while spending money from other sources. This can reduce your Estate whilst keeping aside a ring-fenced fund for your family.
Tax advantaged Investments
Reducing Estate size to help avoid IHT, whilst maintaining access to monies can be difficult to achieve.
There are however, a range of investment options available where additional Inheritance Tax savings could be made. Typically, as long as these investments have been held for a minimum of two years at the point of death, they will qualify for IHT relief on the total investment value.
This is an excellent way of reducing Estate values, whilst retaining control and access to funds in the event that they may be needed in the future. Unlike gifting into Trust or directly to loved ones.
There are different types of investment available to achieve this, with varying degrees of risk applied, so care should be taken before venturing into these types of investment, but the tax savings alone, make them a viable IHT planning solution.
Charitable gifts are considered immediately outside your estate for IHT purposes. Donating to a charity, or even setting up your own charitable trust, can help the causes that are important to you while saving on tax.
Gifts to political parties or other organsations considered to be working for national benefit are also exempt.
If you donate at least 10% of your net Estate to charity, you will receive a 4% reduction on the rate of IHT. This means that your Estate will be taxed at a rate of 36% rather than 40%.
Mitigating IHT is an important objective for many people starting to think about their Estate plan. But reducing tax should never be the main goal. Consider what you would like to achieve with your legacy, and saving IHT will most likely be a natural consequence.
If you would like advice on achieving your Estate planning goals, please don’t hesitate to contact a member of our tax or financial planning teams to find out more about how we can help put a bespoke plan in place for you and your savings.