In the year 2018-19, Britons paid a record amount of inheritance tax (IHT) to HMRC, totalling £5.4bn. But why has so much tax been paid? It is partly because the decade freeze to the nil-rate band – the total value of your estate that can be inherited tax-free. But, it is also because it’s quite complex tax to understand and a sensitive area of tax planning that people are prone to putting off.

However, some of the hardest conversations to have are often the most important.

By incorporating inheritance tax planning into your financial planning process, you can start distributing your money how you want within your lifetime, as well as thinking about what happens when you’ve gone. Not only will you be able to see the people you love enjoying it while you’re here, but you’ll also be reducing the overall inheritance tax bill on your estate.

What is inheritance tax and how is it calculated?

Inheritance tax is the tax on the estate (property, money, and possessions) of someone who has died.

Your estate will not owe IHT if:

• The value of your estate is below £325,000
• You leave everything over the £325,000 threshold to a spouse, civil partner, charity, or local sports club.

But there is something else.

If you leave your home to your children (including adopted, foster or stepchildren) or grandchildren then you may also benefit from the residence nil-rate band (RNRB), or ‘main residence’ band. It is an additional allowance of up to £175,000, so potentially bringing the total allowance up to £500,000 tax-free per individual.

Inheritance tax of 40% is payable on the excess value of your estate over the thresholds.

A reduced rate of 36% could apply to some of your assets when your will leaves an amount to charity (10% or more of the net value of your estate).

Ways to minimise your inheritance tax

Make gifts

There are a few different exempt gifts you can make each tax year:

• You can gift £3,000 each tax year to anyone inheritance tax-free. You can also roll over one previous year’s allowance, if you didn’t use it, making a total of £6,000.
• Wedding or civil ceremony gifts of up to £1,000 per person (or £2,500 for a grandchild or great-grandchild, and £5,000 for a child)
• Gifts out of your income (i.e. Christmas or Birthday presents)
• Payments to help with a relative’s living costs
• Gifts to charities or political parties

You can use more than one of these exemptions on the same person in the same tax year.

You can also make small gifts throughout the year, giving up to £250 per person. You can give as many as you want throughout the tax year, as long as you haven’t used another exemption on this individual.

You can also make gifts that don’t qualify for any of the above exemptions or allowances. However, for these to fall outside of your estate, you must survive 7 years.

Place assets in a trust

Trusts are a very complicated area of IHT planning, but let’s start with the basics.

Think of a trust like a safe; you put some of your valuable assets in it locked away for safekeeping.

You don’t want the safe opened until later, usually once you have passed away. So, you give the code to people you can trust, the Trustees.

The Trustees look after the safe and it’s contents for you. You will have specified how you would like to distribute the safe (in the Trust Deed or your will), and the trustees will follow your wishes.

There different types of trust, each with their own tax treatment, however, most will offer protection of the assets for the beneficiary and a useful way to save IHT.

We recommend you speak to a financial planner or solicitor before setting up a trust.

Leave money to charity

Any money you leave to charity is tax-free. So, this is a very effective way of reducing IHT while supporting your favourite charities.

It is also worth noting that the same rules apply for gifts to political parties and local sports clubs.

If you leave over 10% of the net value of your estate to charity, then some of our assets will be subject to a reduced rate of IHT (36%).

Take out life insurance – but write it into trust!

Taking out life insurance alone does not directly reduce the amount of IHT due on your estate; you need to make sure your policy is written into trust. Otherwise, it will increase the size of your estate and the IHT bill. But by putting aside an insurance policy that will cover the cost of your IHT bill, and writing it into trust, means your beneficiaries will benefit from the full value of your assets.

Keep it in the family

Now, this may seem like an obvious point, but passing your assets to your spouse will be free of IHT; your partner’s inheritance tax allowance rises by the portion of your allowance that you do not use, and vice versa. A married couple could potentially leave up to £1,000,000 tax-free if the house is left to their children or grandchildren (in the 2020/21 tax year).

What to do next

• Start a conversation with your family – The sooner you start having these challenging conversations, the better your succession plan will be, and the more wealth you will be able to pass down to your loved ones.
• Update your will – Your will states who should inherit what, after your lifetime. If you go through a big life event, you need to update your will, ensuring that it is written tax-efficiently and in line with your wishes upon your changing circumstances.
• Talk to a financial adviser – As you can see, there are many different routes you can take to try and maximise your estate and reduce inheritance tax. But knowing which path is right for you, really depends on your circumstances. And this is where the impartial expert advice of a professional financial adviser is invaluable.

By speaking to a professional, you will be able to work through the finer details of this complicated area of tax planning. They will give you a deeper understanding of the options available so that you can develop a plan that’ll protect your legacy.

If you would like to discuss any aspect of this article or your financial plan, then please get in touch with us and speak to one of our financial planners. Our friendly West Bridgford-based advisers are just a phone call or video call away.