Tax planning for your inheritance

Planning how to deal with your assets in a tax efficient manner is an important but potentially complex task. An increasing number of estates will be liable to inheritance tax (IHT) on the owner’s death, so it is vital to consider how your will can be drafted to reduce the amount of tax that will be taken from your estate after you die, freeing up more money for your loved ones.

You can also consider whether to make gifts during your lifetime to minimise your IHT liability but this raises other tax considerations. Elliot Lewis, wills, trusts and estate planning solicitor with Thackray Williams, explains what you need to think about when planning for your inheritance if you wish to minimise your tax bill.

Why should I think about tax now?

The IHT threshold for an individual is £325,000 (also known as the nil rate band) so if your estate is worth more than that on your death, the value of your estate in excess of £325,000 could be taxed at 40 per cent. Many estates will exceed this threshold, particularly given the steep rise in property prices over recent years.

How can my will reduce IHT?

You can utilise various available tax reliefs and exemptions in your will to reduce the tax bill on your death, including:

Spouses and civil partners: gifts made to your spouse or civil partner are exempt from IHT, so the value of any property or share in a property left to your spouse or civil partner will not be taken into account for the purposes of IHT;

The transferable nil rate band: if you survive your spouse or civil partner, the basic threshold available for your estate can be increased by the percentage of the threshold unused when they died. For example, John died leaving an £600,000 estate. He left £130,000 to his son and John’s wife inherits the balance. Only £130,000 out of the £325,000 threshold was utilised, so the unused 60 per cent (£130,000 is 40 per cent of £325,000) is transferrable to the wife’s estate. On her death, her total IHT threshold will be £520,000 (£325,000 plus £195,000);

The residential nil rate band: an additional allowance is available if you leave one residential property to your direct blood descendants, such as your natural children and grandchildren. This is currently £125,000 rising £25,000 each year to £175,000 in 2020/2021. If you own more than one residential property your executors will nominate which one will qualify;

Charities: gifts made under your will to UK charities and political parties are also exempt from IHT; and

Will trusts: a carefully structured will trust can protect an inheritance from tax charges. You can leave money or property on trust for your beneficiaries in accordance with your specified wishes, for example, to fund their university education or a deposit for a property.

How else can I reduce my tax liability?
If funds allow, consider making gifts during your lifetime to reduce the value of your estate and the potential IHT liability on death. You can make as many gifts of £250 to anyone you like without them being liable for IHT. You also have an annual exemption of £3,000, so you can give up to £3,000 to someone without incurring IHT (or £1,000 each to three people);

You could also consider making a gift known as a ‘chargeable transfer’. Although IHT may be payable if you die within seven years of making the gift, the potential tax decreases each year until it falls outside of your estate after seven years.

Further reliefs and exemptions may be available via business or agricultural property relief and shared property relief.

Are there other tax implications?

Tax planning for inheritance must include consideration of other taxes, notably capital gains tax (CGT) which can be a trap for the unwary. Importantly, CGT liability dies with the individual, but it may arise if you make lifetime gifts.

A gift of property (other than your main home) or an expensive work of art could, for example, give rise to CGT on the increase in value since you acquired it. This means that whilst a lifetime gift would reduce your IHT liability on death, it could incur an immediate CGT bill when the gift is made. You need to carefully consider whether it makes more financial sense to make a lifetime gift and pay a CGT bill now, or deal with it in your will and save IHT on your death.

Finally, there may also be income tax considerations if you create a trust, as the income from a trust fund is liable to income tax.

This is a highly complex area of law, and to find out about how best to navigate the tax implications you should see a specialist solicitor who specialises in inheritance tax planning.