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How to stop worrying about inheritance tax as a UK citizen
Effective Inheritance Tax planning is an important component of financial planning process, as failure to do so can potentially result in your beneficiaries having to pay a hefty tax bill upon your passing, shrinking the amount they will receive.
There is a collection of different ways in which Inheritance Tax can be mitigated and this article will explain some of them briefly.
Having a will in place
Having an up to date last will and testament is a key part of the estate planning process as it ensures your assets are distributed after your passing in accordance with your wishes. Without having a will in place your assets will be distributed according to intestacy rules and if your estate is in excess of the threshold mentioned below, there is likely to be a large and unavoidable IHT bill.
Understanding inheritance tax rates
The nil rate band (NRB), also known as the inheritance tax (IHT) threshold, is the amount up to which an estate has no IHT to pay.
Individuals are entitled to a nil rate band amount of £325,000 – which is tax-free when passed on to a beneficiary. Individuals are also entitled to £150,000 (residence nil-rate band only applicable if you are leaving your main residence to a direct descendent – only applicable against the value of the property) tax-free for the primary residence per person. This nil rate band is transferable to a spouse or civil partner upon death, resulting in a total IHT exempt amount of £325,000 X 2 = £650,000 + (£150,000X2=£300,000) = £900,000.
You can transfer your entire estate to your spouse IHT free.
Anything exceeding this amount is subject to a 40% Inheritance Tax rate.
Once your estate is over £2m you lose your residence nil-rate band at a rate of £1 for every £2 over the £2m threshold.
Gifting your assets to your loved ones
If you gift your assets to your loved ones and you survive for 7 years, then your gift is exempt from IHT. If you die within the first 7 years after making the gift, then there is a tax liability.
Death within 7 years of gift being made tax rate:
If death occurs the first three years of the gift being made
100% of the 40% tax bill will apply
In year 3-4 80% of 40% – effective rate 32%
year 4-5 – 60% of 40% – effective rate 24%
year 5-6 – 40 of 40 – effective rate16%
year 6-7 20 of 40 – effective rate 8%
After 7 years there is no tax to pay on the gift
There are ways in which you can transfer parts of your estate to your loved ones without paying IHT. Each year you can gift your ‘annual exemption’ of £3,000 to anyone of your choice. This is a cumulative amount which can be carried forward to the next year – but only for one year.
Each tax year, you can also give away:
· wedding or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, £5,000 for a child)
normal gifts out of your income, for example, Christmas or birthday presents – you must be able to maintain your standard of living after making the gift
· payments to help with another person’s living costs, such as an elderly relative or a child under 18
· gifts to charities and political parties
You can use more than one of these exemptions on the same person – for example, you could give your grandchild gifts for her birthday and wedding in the same tax year.
Putting your assets into trust
Another common method of reducing the size of your estate is to put a portion of it into a trust. Moving assets into a trust legally separate you from the asset and might prevent the assets from being subject to IHT*. Trusts can be used in a variety of ways and ensure that your beneficiaries are able to access your assets after your passing. Once again, the same gift rules apply, meaning seven years must pass before the asset can be exempt from IHT.
Take out life insurance
You can cover any potential liability for IHT by taking out a life insurance policy which includes payment for a potential IHT bill.
Give assets away that are free from CGT
If you hold assets where the value is now lower than when you purchased it, these can be passed on without attracting any CGT. Any recovery in the value of the asset would accrue in the estate of the recipient and the potential gain would be free from an IHT liability after 7 years once again.
Anything left to charity will be free from IHT. Leaving 10% of your assets to charity will reduce your IHT rate on the remainder from 40% to 36%.
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