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A guide to inheritance tax planning: How to leave more to those you love most

It's never too early to start planning for your families future.

Nothing, as the old saying goes, is certain but death and taxes. And in the case of inheritance tax, the two come as a pair.

But whilst we may not be masters of death (yet), having to pay maximum inheritance tax is less of a foregone conclusion.

At Robertson Baxter, we don’t just work for our clients, we work for their families.

Leaving the fullest legacy to our clients’ future generations is one of our core missions.

That’s why we’ve created this guide to inheritance tax planning, outlining what inheritance tax is, what it means for you and how you might leave more to those you love most.

What is inheritance tax?

Inheritance tax – or, as it’s not-so-affectionately known, “Britain’s most hated tax” – is a tax on a deceased person’s estate.

Inheritance tax becomes payable to HMRC when someone dies with an estate worth more than a certain amount. It’s based on the total market value of someone’s entire possessions, from stocks and shares to family heirlooms.

Inheritance tax must be settled before beneficiaries can access their inheritance. As such, beneficiaries cannot use gains from the deceased person’s estate to settle an inheritance tax bill.

What is the inheritance tax threshold?

So, the big question – what will you pay?

Inheritance tax doesn’t apply to the first £325,000 of someone’s estate. This inheritance tax threshold is known as the nil rate band.

Further, homeowners with estates valued at below £2m are allowed an additional residence nil rate band (RNRB). This allows people passing on the family home to a direct descendant (children, grandchildren or other lineal descendants) to have an extra £150,000 shielded from inheritance tax.

Any amounts above this inheritance tax threshold are taxed at a flat rate of 40%.

Let’s take an example to show how this works:

Richard passed away leaving an estate worth £1,000,000, including Richard’s main residence, worth £350,000. Richard left everything to his only child, Michelle.

Michelle, as a direct descendant, must pay the following to HMRC:

{£1,000,000 – £325,000 – £150,000} x 40%
= £525,000 x 40%
= An inheritance tax bill of £210,000

Remember, Michelle can’t access her father’s estate until she pays the £210,000 – and, crucially, can’t use the estate to pay it.

To pay the inheritance tax, Michelle could:

• Ask family to help. This would be difficult as Michelle is an only child.
• Take out a bridging loan, at a costly rate of interest.
• Remortgage her home.
• Pay her inheritance tax bill in annual instalments – and be charged interest by HMRC for the privilege.

Had Richard never been a homeowner, Michelle’s inheritance tax bill would have been even greater, as she wouldn’t have been eligible for the £150,000 protected from tax as per the residence nil rate band.

{£1,000,000 – £325,000} x 40%
= £675,000 x 40%
= An inheritance tax bill of £270,000

Are there any exemptions to inheritance tax?

The big one is that transfers between spouses don’t incur inheritance tax. Should you leave your estate to your husband, wife or civil partner, they won’t pay any inheritance tax when you die. They can also inherit any unused nil rate band you leave behind.

Going back to our example, imagine Richard had a wife, Catherine, who died before he did. Catherine left her entire estate to Richard, which meant Catherine didn’t use any of the nil rate band or residence nil rate band while passing on her estate.

This greatly improves Michelle’s situation. Why? Because Richard now has two nil rate bands (£325,000 inheritance tax threshold x 2 = £650,000) and two residence nil rate bands (£150,000 RNRB x 2 = £300,000*) to use up before his estate becomes taxable.

In this reality, Michelle pays:

{£1,000,000 – £300,000 – £650,000} x 40%
= £50,000 x 40%
= An inheritance tax bill of £20,000

This amounts to between £190,000 and £250,000 saving compared to our above examples – a significant reduction.

How can I leave more to my loved ones?

As we’ve discussed, an inheritance tax bill can place a heavy financial and emotional burden on people already struggling with losing a loved one.

So, what can you do to lighten the load?

1. Make a will

Making a will doesn’t reduce your inheritance tax bill but it does make life less stressful for those you leave behind.

Even simple wishes can require forethought. For example, you may want your estate divided equally between your two children – but what if one of them is underage when you die? Who should look after their inheritance while they’re a minor? And do you want your online shopping-addicted son getting their hands on a sizeable inheritance in one fell swoop when they turn 18?

Making a will inspires you to consider and plan for these issues, creating stability for loved ones when you pass on.

So that, when the time comes, instead of squabbling over who’s owed what, your relatives are reminiscing over your impeccable comic timing (or lack thereof), embarrassing dance moves and the time you incinerated your eyebrows at the annual family barbecue…

2. Stay under the inheritance tax threshold

Our clients often think long-term. They don’t just earn money for themselves, they do so for their family’s future generations. They’re so good at saving, in fact, they sometimes forget that money is a tool to help them enjoy today, not just to save for tomorrow.

As strange as it sounds, sometimes the best thing you can do to save your family money is to spend your money, thus reducing your children’s potential inheritance tax bill. It’s also a great way to justify sailing away on that world cruise, splurging on that Tesla sports car or putting up that palatial orangery…

Remember, it’s important to treat yourself, not the tax man.

As a (very) rough guide, these are the permitted tax-free allowances in the 2019/20 tax year, depending on your circumstances:

Nil rate band entitlements:

Single person
Passing on the family home to a direct descendent?
Yes – RNRB Applies £475,000
No – RNRB Not Applicable £325,000

Married couple/civil partners
Passing on the family home to a direct descendent?
Yes – RNRB Applies £950,000
No – RNRB Not Applicable £650,000

We call this a rough guide because the above table assumes that the first person to die in a couple will leave 100% of their estate to their surviving spouse or partner. It also assumes the property to be passed on is worth at least the maximum residence nil rate band (you can’t have a higher RNRB than your home is worth).

So whilst the above can help gauge whether inheritance tax planning is likely to be a concern for you, if you want an exact figure, it’s important you seek professional advice.

Talk to an inheritance tax expert today.

3. Give generously (but not too generously)

You can give away up to £3,000’s worth of gifts each tax year without them falling into your taxable estate. These are known as exempted gifts. For one year only, unused allowance can be carried forward to the next year.

You can also make normal gifts out of your income, such as regular deposits into a savings account for a grandchild. So long as the gifts aren’t so expensive that you sacrifice your quality of life to afford them, you can spend what you like. (The Money Advice Service recommends speaking to a solicitor or estate planning specialist before making use of this exemption.)

Further, you can give someone as many gifts as you wish worth up to £250 during a tax year, providing you haven’t used another exemption on that person.

So you don’t fall foul of the rules, we always recommend talking to a legal or tax expert if you intend to make the maximum use of these exemptions.

4. Beware the seven-year rule

Be careful when giving away assets or buying gifts if you’re doing so with inheritance tax reduction in mind.
Gifts that don’t qualify as exempt are known as potentially exempt transfers, or PETs. For a PET to be inheritance tax-free, you have to live for seven full years after giving it. If you die within seven years, the PET will take a chunk out of your nil rate band – or use it up entirely if the gift was large enough.

Also, if you make successive PETs over a long period of time, gifts can remain in your estate for up to fourteen years.

5. Make an appointment with a Robertson Baxter financial adviser

There are other steps you can take to chip away at that inheritance tax bill, but most of these require help from a qualified financial planner. Fortunately, this is where we can help.

In a meeting one of our advisers, you might discuss:

  • The role pensions play in inheritance tax planning
  • Why you don’t have to be a business owner to qualify for Business Relief (another form of inheritance tax relief)
  • Whether you might benefit from setting up a family investment company (FIC)
  • How to get the most out of a trust investment
  • Where life insurance comes into play
  • How leaving your money to charity affects inheritance tax
  • How giving gifts – so long as it’s done in the right way – can make an impact

Speak to a Robertson Baxter financial adviser today.

We’ll cover the above topics in future blogs, so refer back to our website for further future insights.

We understand that all this might sound a little complicated. But we’re here to help. We help you navigate through all options and potential outcomes, and we never pressure anyone into a decision. Our approach is to listen, offer straightforward advice, answer questions simply and honestly, and help you decide what’s right for both you and your family.

If you’d like to discuss anything about inheritance tax – from inheritance tax planning to exemptions – contact a Robertson Baxter financial adviser today.

Please be aware that:

Levels and bases of, and relief from, taxation are subject to change.

The above information must not be construed as advice and you must seek individual advice relevant to your circumstances from a financial adviser.

Robertson Baxter Limited is directly authorised and regulated by the Financial Conduct Authority (FCA). FCA Registration Number: 462209

Guidance and advice are subject to the UK regulatory regime and are therefore restricted to consumers based in the UK.

The Financial Conduct Authority does not regulate tax and trust advice.

The Financial Ombudsman Service is available to sort out individual complaints that clients and financial services businesses aren’t able to resolve themselves.