Inheritance tax: What is it?
If your estate (all of your possessions) exceeds a specific size, your beneficiaries may be required to pay inheritance tax (IHT). The IHT nil-rate band allows you to leave your beneficiaries up to £325,000 tax-free. Everything above that amount will be subject to tax, often at a rate of 40%. This may result in a very high bill for huge properties.
Who pays inheritance tax?
If you have a will, the executor is in responsibility of organizing the tax payments to HMRC. If you don’t have a will, an executor who handles your estate will take care of this.
Taxes are often paid with cash from the estate (or money made by selling estate assets). After the tax on inheritance has been paid, the remaining assets of the estate are distributed.
Although the procedure of transfer assets from an estate, known as probate, occasionally takes longer than six months, IHT must be paid to HMRC within that time frame. This consistently poses a challenge. It can seem like a catch-22 because probate cannot be granted until IHT has been paid. But there are other possible solutions.
Solution 2: If there isn’t enough money in the estate to cover the IHT tax, the executor can borrow money from a bank, refund it when succession is granted.
Solution 3: If a portion of the estate consists of real estate, IHT on the property may be paid over a period of up to 10 years in installments.
There are numerous more situations in which it might be challenging to pay the IHT charge in full. If you are the receiver of an estate and are in this situation, seek the advice of a financial advisor.
How should I go about structuring my estate for taxes?
If you leave your entire estate to the spouse or civil partner, they won’t be liable to inheritance tax. Additionally, some beneficiaries—including charities—are exempt from paying taxes on whatever you leave to them.
During your lifetime, there are several ways to reduce the amount of your taxable estate, such as making charitable donations, setting up trusts, and implementing other planning strategies.
Using gifts
IHT is not applied to gifts made seven years or more before your death. If you continue to get rent from a second property, for example, it would be considered a “gift with reservation of benefit” and would thus continue to be included in your estate even after seven years. The same rules would still apply if you ‘gave away’ your house but still living there for free.
You don’t have to be concerned with the seven-year limit when giving lesser presents. Any tax year allows you to give up to £3,000 in gifts without incurring IHT.
If you haven’t utilized the previous year’s allocation, it rolls over to the following year, allowing a married couple to donate up to £12,000.
Additionally, parents may donate £5,000, grandparents may contribute £2,500, and anybody else may give up to $1,000 as wedding gifts. Last but not least, any presents given to a person that are valued £250 or less are exempt.
Using trusts
A trust enables you to set aside funds to support the beneficiary in a specific way or at a specific point in time (for example, to pay for college expenses). Trusts may be established outside of your estate and thus be exempt from inheritance tax.
A life insurance plan can be established particularly to pay the IHT bill. The policy payout itself won’t be taxed and can be used to pay HMRC if it goes into a trust that is separate from your estate.
Trusts are a specialized subject, so before creating one, make sure to first speak with a financial advisor and a lawyer.
The golden rule: make a will!
Making and maintaining a will is the most crucial step in inheritance planning. Additionally, you must name a trustworthy executor because they will be in charge of seeing that the IHT debt is paid from your estate. Your lawyer can assist you in creating a will.