Death and taxes are life’s certainties, or so we’re told, and if you’re a regular reader of any publication about wealth, you will know that this adage of Benjamin Franklin is one that private client professionals like to quote - a lot! But tax, or the amount that will be owed on your death at least, can be given more certainty, and greatly reduced, if you plan for it.
How tax efficient is your estate and what can you do about it?
1. Make a will and keep it updated.
If you don’t have a will, unwanted tax consequences is only one of your problems. The intestacy rules will determine where your estate goes and the associated tax consequences. For example, if you’re married with children but you don’t have a will, your personal chattels and up to £250,000 of your estate will pass to your spouse or civil partner. The remainder will be divided as to 50% to your spouse or civil partner and 50% for your children. If the amount that passes to your children is above the available reliefs, Inheritance Tax will arise. However if you had left your entire estate to your spouse or civil partner in a will, either outright or in trust, there would have been no Inheritance Tax to pay on the first death.
2. Are you making use of all the exemptions that you are entitled to?
As mentioned above, assets left to a spouse or civil partner, either outright or in a trust, can pass completely free of Inheritance Tax provided that both spouses are UK domiciled or both spouses are non UK domiciled. If there is a mismatch of domiciles, then the full spouse exemption is not available.
Each person has a nil rate band of £325,000 which can pass tax free. If any part of this was unused on the first death, it can be transferred to a surviving spouse or civil partner on their death. However, if one or both of you were previously widowed, you will need to take action in your will to make sure that the nil rate bands of your previous spouses will not be wasted.
In April 2017, a new exemption called the residence nil rate band was introduced. This year an extra £100,000 per person can pass free of Inheritance Tax but by 2020/21, the exemption will be worth £175,000 per person which is again transferrable between married couples and civil partners. This means that as much as £1 million could pass tax free on the second death. To qualify, a residential interest must be left to children or grandchildren and the estate must be worth less than £2 million on the second death. For estates worth between £2 million and £2.35 million, the relief is tapered and estates worth above £2.35 million will not benefit from the relief at all. If your estate is “borderline” (around the £2 million mark), planning carried out before and on the first death can help to reduce the taxable estate for this purpose. Deathbed gifts can also assist in bringing the estate below the £2 million threshold.
If you own a business, you should also be looking to plan on the first death. Assets that qualify for business property relief can pass free of tax but this valuable relief can be wasted if the assets are left to the spouse or civil partner. Instead, a properly written will can preserve this relief whilst still allowing the spouse to benefit from these assets.
3. Have you properly structured your life policies, death-in-service benefits and pensions?
Life policies should be written in trust to ensure they do not form part of the taxable estate. Death-in-service benefits should be nominated to a trust so that they do not form part of the taxable estate on the second death. By contrast, it may now be more tax efficient to nominate your pension to be received by an individual as an income rather than nominating a trust for this purpose so that these funds can remain in the pensions wrapper and therefore out of the estate of the survivor for Inheritance Tax purposes.
4. Finally, are you gifting (if you want to)?
Gifts made within seven years of death are brought back into account for Inheritance Tax purposes meaning that any gift given before this period passes completely free of Inheritance Tax (although not Capital Gains Tax, if applicable). It is also possible to give away £3,000 per year without the risk of these sums being brought back into account and to give away surplus income, if it can be proved to be such, without any Inheritance Tax consequences. Proper advice taken in this regard can save thousands of pounds in Inheritance Tax later on.
A well thought through estate plan and a properly drafted will can increase the certainty regarding the Inheritance Tax position on your death. Death may be a certainty but a large Inheritance Tax bill need not be.