No-one likes to hand over a chunk of their hard-earned cash to the taxman but as the old saying goes; there are only two things in this life which are unavoidable: death and taxes.
But rather ironically it is the combination of exactly these two things which can cause such frustration.
If you have wealth or assets which you have built up during your lifetime, the chances are you will want to pass them on to look after your loved ones once you are no longer around. Unfortunately, if your estate is above the tax threshold, a considerable proportion of the money intended for your family and friends could end up with HM Revenue and Customs.
The good news is there is a way to legally reduce the amount of Inheritance Tax which could be payable in the event of your death. We take a look at some of the simplest ways you could steal some of your money back from the taxman, and leave more for your family.
How IHT works
When you die, everything you owned including property, money and assets such as art are valued to see if they are worth more than the nil rate threshold.
If the combined value of these items comes to more than the nil rate threshold – currently set at £325,000 and due to remain at this level for at least three more years – then tax will become payable. If on the other hand, your estate is worth less than this amount, no Inheritance Tax (IHT) will be due.
For those individuals whose estate is over the threshold, an eye-watering 40% will be taken in tax of the excess amount. This can result in the taxman swallowing a sizeable chunk of what you may have thought would be left to protect your loved ones.
The nil rate band for IHT is the same for everyone, both single and married, but those in the latter group can effectively ‘share’ assets and by doing so double the application of the nil rate tax band.
Trust in a Trust
If you have taken out life insurance which you specifically want to be paid to certain individuals, it may be a good idea to put the policy in Trust. By doing so you automatically remove it from the administration of the estate which means that not only can the money be paid out sooner – as you don’t have to wait for Probate to be granted – but it also allows it to be paid directly to the individuals you chose.
However, putting life insurance policies into Trust is not just a great way of avoiding the taxman’s hands; it also provides a means of paying Inheritance Tax when the time arises.
If you have calculated that your estate will have to pay IHT, you can take out a type of life insurance specifically designed to cover the bill which will arise when you die. A whole of life policy, this type of life insurance is intended to never mature or expire and providing you continue to pay the correct premiums, the cover will remain in force. Upon your death the money is released ahead of Probate to ensure the estate can properly pay the IHT bill. This effectively means that all of your money can be split between your friends and family, and none will be paid to the taxman.
Love thy neighbour
Of course, whilst it’s an excellent idea to protect yourself against the tax bill when it arrives, it’s also worth considering what you can do in advance to reduce the actual cost.
One way to do this is to give your friends and family gifts whilst you are still alive so there is less to share out after you have gone.
This can be an excellent option if you want to reduce your overall IHT bill but unfortunately the taxman has put some measures in place to stop you taking full advantage of this. Although it’s possible to make a certain number of tax-free gifts during each fiscal year, in order to retain the tax-free status, you must survive for seven years after the money or item is gifted. For each year you are alive, the tax liability reduces until it disappears completely after seven years.
This seven year law prevents individuals from simply gifting away their entire estate on their death bed and in doing so, depriving HM Revenue and Customs from money they would have had.
The rules around how much you can give, to whom and when can be quite complex so if you want to ensure you avoid increasing your IHT liability it may be a good idea to seek financial advice before proceeding.
Talk to the professionals
There are many other ways to cut down on the amount of IHT which will be payable in the event of your death such as making a Will, sharing your nil rate threshold with your spouse and opting for equity release on your house.
However, the rules which govern all of the different options can be rather complex and difficult to understand. It’s therefore entirely advisable to book an appointment with your accountant – or to sign up with one if you haven’t already done so. They will not only be able to accurately calculate what your IHT liability is likely to be, but also explore all the different tax efficiencies which may be available for you to use.
No-one wants to think about what life might be like when we are no longer around but it’s important to get on top of your tax planning in order to ensure your loved ones are well looked after if something happens. Taxes are indeed an essential part of society but why pay more than you have to? There are many ways you can reduce your liability; talking to an experienced accountant will help you understand how you can protect your estate and make sure that as much as possible passes on to your loved ones rather than the taxman.