Many people say that there’s nothing after death. With respect, HRMC would disagree. Inheritance tax raised a record £5.1bn from Britain’s newly-deads in 2016/2017, an increase of 22.9% on the year prior. That certainly is money for old bones!
Inheritance tax laws have given rise to arguably one of the country’s most controversial levies. However, whether you agree or disagree with it, inheritance tax is governed by some pretty complex rules. You might be thinking that you need a specialist inheritance tax lawyer to help you out but you couldn’t be more wrong.
Inheritance tax planning is actually the realm of decent accountants with the right qualifications and a few years of experience behind them. Someone like Karl Watts, managing director of Sunny Accountants, fits that bill exactly.
After a recent big success where Karl reduced a client’s potential inheritance tax bill from £350,000 to zero, he’s spent a lot of time with us putting this blog post together to show you how you can achieve a similar result for yourself and your family.
We’ll cover everything in this article. It’s a long-ish read so you might want to print it off. But the 10-15 minutes of your life (or what’s left of it!) you give to this article will pay you and your loved ones back many times over.
As you’re reading, be sure to make notes of which parts of inheritance tax you want to know the most about or the areas you may feel the most concerned about. Then, with your notes to hand, give Karl a call, send him an email, or fill out the enquiry form at the bottom of this page.
Your initial consultation with Karl is free. He’ll find out about you and your situation and what you want to achieve. He’ll explain everything to you in friendly, non-jargony way as free from accountant terms where possible – so don’t worry, he won’t bore you to death(!) before he’s finished giving his advice.
So, let’s start with the basics...
What is inheritance tax?
Inheritance tax is payable on the "estate" you leave behind.
Your estate is the difference between what you own and what you owe at the time that you die.
What you own includes:
- any property shareholding
- any business shareholding
- any vehicles
- any cash in the bank
- anything of worth
- any Premium Bonds (use this link if you can’t find the certificates)
- any ISAs, shares, investments, or assets in a trust
- rent you’ve paid upfront
If you had an overdrawn director’s loan account from a limited company in which you had a shareholding, the limited company may make a claim on the estate for repayment. If the company decides to write the loan off, it may be considered an asset which will add to the value of your estate.
What you owe includes:
- outstanding mortgage
- other finance facilities, including loans, overdrafts, and credit cards
- household bills, including utilities and water
If you have a director’s guarantee to the bank or another lender so that your limited company could access finance, the lender may call on the director’s guarantee and try to enforce it against your estate if your company can not pay off the loan or finance facility in full on your death.
This might cause severe financial problems for your family if they don’t have the cash. We would urge you to check the terms and conditions of any director’s guarantee you’ve given and share your concerns with a suitably qualified solicitor.
If the difference between what you own and what you owe is less than £325,000 (your inheritance tax threshold), there is no inheritance tax to pay. There are other thresholds but we’ll cover those later on in this article.
Inheritance tax on life insurance
Life insurance is peace of mind for many of us. If you get run over by a bus tomorrow, any outstanding mortgage on your primary residence will be paid off by the insurer. Quite often, depending on the terms of the life insurance you take out, there may be cash left over too.
If your life insurance covers just the remaining mortgage on your primary residence, the same amount of money will be added to the “what you own” and “what you owe” columns, cancelling each other out.
However, if you’ve insured your life for more than the value of the outstanding mortgage, the excess will be added to the “what you own” column. That may be taxable but we’ll look at how to protect yourself against that later in this piece.
Inheritance tax on term insurance
Term insurance, sometimes known as family income benefit insurance, is also a favoured option for many people looking to provide for their loved ones after they die.
Many people feel uncomfortable with the idea of just getting a big lump sum like with life insurance and they’d prefer to receive a fixed monthly income instead. Often, a person will take out both life insurance and term insurance as it offers double coverage for those we leave behind.
Problems with inheritance tax can arise with term insurance however. Let’s say you took out term insurance offering your family £50,000 a year in payments for a 20-year period but you died 7 years into that period.
Your family would be entitled to 13 years’ worth of payments at £50,000. HMRC will want to calculate the total amount your family would be paid out over the period - £650,000.
If this was to be the only benefit passed on to you, that £650,000 is in excess of the £325,000 threshold. The £325,000 over the threshold would be taxable at 40% resulting in an inheritance tax bill of £130,000.
The payment of £130,000 in inheritance tax would be expected by HMRC at the end of the sixth month after your death at the latest, even though the policy had only just started to pay out to your loved ones.
This, and any excess on your life insurance, would create big cash flow problems for your family. What’s the best way to handle life insurance and term insurance from an inheritance tax perspective?
Inheritance tax and trusts
You can place both your life insurance policy and term insurance policy into a trust to mitigate the effects of inheritance tax.
A trust is a legal arrangement between you and “trustees”. You instruct your trustees on who should receive the benefits of your life insurance and term insurance policies when you’ve gone. This arrangement also ensures that, on most occasions, your loved ones receive the payments quicker than if the policies formed part of your estate.
When you write your life insurance or term insurance policies in trust, their values do not contribute to the overall value of your estate.
Getting life insurance and term insurance optimised for inheritance tax by using trusts is HIGHLY recommended. Make sure that, when you speak with Karl, you talk about placing your insurance policies in trusts to him.
How do inheritance taxes work?
You’re charged inheritance tax at 40% of the value of your estate above the threshold.
So, if you have an estate worth £750,000 and your tax-free threshold is £325,000, the difference of £425,000 is charged at 40%, creating an inheritance tax bill of £170,000.
How you plan for inheritance tax can save you tens of thousands or hundreds of thousands of pounds. Your family may get away with paying nothing at all. But it’s vital to plan.
Before we get onto that, let’s look at some more of the rules governing inheritance tax.
Does inheritance tax apply to property?
By 2020, inheritance tax on primary residential property will be scrapped when parents or grandparents pass on their home up to the value of £1m. If there’s just one parent or grandparent, this limit is £500,000.
At the time of writing, it’s £425,000 per person or £850,000 for a couple.
These rates only apply when a home is passed on to children (including stepchildren, foster children or adopted children) or grandchildren. If there is not the familial link, normal inheritance tax thresholds apply for property transfers.
In 2020, homes valued between £1m and £2m will attract inheritance tax at the standard rate above the £1m level. Anything over £2m, parents or grandparents’ property will lose £1 of the primary residential property allowance for every £2 of value above £2m.
7 year inheritance tax rule - inheritance tax on gifts
Now this is a question Karl gets asked a lot - possibly the best-known of all the inheritance tax rules.
The public perception on the regulations surrounding inheritance tax and gifts is possibly one of the most misunderstood, so let’s have a look at what HMRC actually say.
You can give away £3,000 worth of gifts every tax year and they don’t count towards the value of your estate. You get a £3,000 “annual exemption” per person you give gifts to. You can carry any unused exemption forward to the following year but for only one year.
You can gift £5,000 to your child, £2,500 to your grandchild or great-grandchild, or £1,000 to anyone else as your contribution towards a wedding or civil ceremony.
As long as you can maintain your standard of living, gifts out of your normal income for Christmases and birthdays are exempt.
You can help with another person’s living costs – for example an elderly relative or a child under the age of 18.
Charitable and political party donations are also exempt.
So, what does the 7-year rule apply to? Anything that has value, like money itself, property, or valuable possessions that you give away. If you sell it to someone else for less than it’s worth, the difference in value is counted as the gift.
If the person dies within 3 years of giving you the gift, the full 40% inheritance tax on it is due. But there is inheritance tax taper relief and the amount of inheritance tax due decreases as time goes on like this:
|Years between gift and death
|3 to 4
|4 to 5
|5 to 6
|6 to 7
|7 or more
So, after 7 years, no inheritance tax is payable as it’s no longer considered part of your estate.
Inheritance tax pension rules
This is complicated (isn’t everything?!) but it’s possible to pass your pension onto a loved one and for the value of your unused pension not to count towards the value of your estate so it avoids inheritance tax.
In the way that you can have your life insurance and term insurance held in trust which avoids inheritance tax, your pension is, in most cases, held in a trust too.
If you haven’t retired yet or drawn down any pension funds and want to pass it on a lump sum:
- you can pass your pension on free of inheritance tax if you die before you’re 75 and your beneficiary will pay no income tax on it.
- if you’re older than 75, you can pass it on free of inheritance tax but the person who gets the benefit will have to pay income tax.
If you haven’t retired yet or drawn down any pension funds and want to leave an income:
- if you die before you’re 75, your beneficiary will not pay any income tax whether they draw it down or take out an annuity on it
- if you die at 75 or later, any annuity or drawdown received is subject to income tax.
- if you’re 75 or older when you die, all lump sum or income payment will be subject to income tax
If you’ve bought an annuity, this is the situation:
- if you die before you’re 75, all lump sum or income payments are free of income tax (except if the annuity bought is a scheme pension)
- if you’re 75 or older when you die, all lump sum or income payment will be subject to income tax
These rules changed in 2015 - the rules before were awful. This is a really positive change for you and the dependant or beneficiary you bequeath your pension to. In addition, the fact it doesn’t add to the value of your estate is a big bonus.
If you’re paying into a pension and want to talk about how to pass them on to a loved one, be sure to bring it up with Karl.
Is there an inheritance rate nil rate band?
Yes. There is an inheritance rate nil rate band on estates worth less than £325,000.
Does inheritance tax apply to spouses?
No. There’s no inheritance tax for married couples or for civil partners to pay if you leave everything to your spouse or civil partner and they’re living in the UK at the time.
Is there an inheritance rate nil rate band if I leave my estate to charity?
Yes. There is an inheritance rate nil rate band on all estates if you leave everything to a charity or a community amateur sports club.
If you leave more than 10% of the value of your estate to charity, then your inheritance tax rate reduces from 40% to 36%.
Inheritance tax threshold 2017
Inheritance tax thresholds used to change every year. As we mentioned earlier, the current inheritance tax threshold is £325,000.
This has been the rate since 6th April 2009. Prior to that, the threshold limit changed virtually every 12 months.
Now we know why HMRC collects more and more inheritance tax every year!
Who pays inheritance tax?
“Inheritance tax – who pays?” is, understandably, the first question accountants and solicitors hear from relatives when they learn that inheritance tax is payable on their deceased loved one’s estate.
The tax owed is worked out by the executors of your will. It’s their responsibility to make sure that they pay what is owed to people within sixth months of the end of the month in which you died.
It’s also your beneficiaries’ responsibility to make sure that they pay any inheritance tax due by the end of the sixth month after you die. They can pay via their own bank account or pay from accounts owned by you.
Your beneficiaries can begin to make payments before the final inheritance tax is known by making payments on account. If they don’t pay the full amount by the end of the sixth month after your death, HMRC will begin to charge interest.
Which inheritance tax form do I use?
There are no inheritance tax forms as such. To pay inheritance tax, your beneficiary needs to apply for an inheritance tax reference number from HMRC at least 3 weeks before making their payment. They can do so online or by post using an inheritance tax reference number application form.
How much inheritance tax on £1 million estates? aka Inheritance Tax Avoidance
Inheritance tax avoidance is not about cheating the taxman or cheating other taxpayers. It’s all about making sure that your relatives don’t have to face the hardship, worry, and hassle that a huge inheritance tax bill will bring.
So, the answer to the question about how much inheritance tax your beneficiaries would pay on a £1m estate is – it depends how good your accountant is!
Let’s look at how Karl Watts of Sunny Accountants saved one of his customers £350,000 with his very own inheritance tax calculator.
How Karl Watts saved one customer £350,000 on inheritance tax
“I was approached by another accountant to provide consultancy services for a client of his who was worried about inheritance tax.
He had over £1million in assets and he was aware that the nil rate band was £325k and he was absolutely convinced that he was going to be taxed at £1.2 million minus the threshold of £325,000. That would be 40% of £875,000 or a £350,000 inheritance tax bill.
My client had run a successful convenience store as a sole trader. He diversified into commercial and residential property but had no other substantial assets
Married with 3 children and grandchildren, he wanted to pass everything equally to his 3 children and he doesn't want them to pay any tax. Completely understandable!
A sharp and intelligent operator, he was however unaware of the potential to transfer his or his wife's nil rate band to the surviving partner as long as everything was bequeathed to the other.
I was able to advise him that his business qualifies for Business Property Relief and that made it free from inheritance tax.
I told him the conditions he must satisfy to obtain the relief and made him aware of:
- the new resident nil rate band,
- how it operates, and
- how to ensure he gets it.
This means that his main residence also has real potential to avoid inheritance tax. We talked about the 7-year rule and how gifts made in his lifetime can potentially create a capital gains tax issue.
I advised that some of his properties have only increased in value by a small amount and he should consider gifting one of those now. Plus, after he’s done that, he should do it every 7 years because any capital gains tax due will be minimal unless they increase in value dramatically
I was able to advise that commercial property he uses for the business qualifies for 50% Business Property Relief.
Working with my client, that led to a decrease in his children’s potential inheritance tax bill from £350,000 to ZERO! A happy man and a happy family. Result!”
Inheritance tax helpline
Karl is currently offering an inheritance tax helpline service for clients via phone, email, and the web form at the bottom of the page.
Let Karl know what you want to achieve with your inheritance tax planning and book a free appointment with him.
For a free chat on how we can help you, please complete the contact form below and we will be in touch.