Discover the Importance of Inheritance Planning

It's a well-known fact that death and taxes are inevitable. However, it's ironic that combining these two can lead to expensive and complex issues. Due to inflated house prices, many people are now paying inheritance tax (IHT), which ultimately benefits the government. The government earned a record-breaking £7.1 billion from IHT in the previous financial year, with HMRC collecting £1 billion more than the year before.

The graph below highlights how the Inheritance tax receipts for the HMRC have grown over the years and are projected to cross £8 billion by 2027.

IHT is typically levied at a rate of 40 per cent on the value of an estate above the "nil rate" allowance of £325,000 or £500,000 if you leave your primary residence to a direct descendant. Anything that you leave to a spouse or civil partner is IHT-free. Frozen tax thresholds are dragging many families into paying the tax.

Despite the growing house prices and asset inflation over the years, the £325,000 threshold has remained unchanged since 2009. It is predicted that it will remain frozen until 2028.

Although IHT is a tax that applies only after death, planning for it while you are still alive is crucial. The rules can be complicated, and it's simple to make mistakes that could cost you.

Here are a few things that can help avoid the traps of IHT.

Make a will:

According to a survey conducted by Canada Life in March, half of the 2,000 adults surveyed did not have a will. Shockingly, even one-third of those aged 55 and over did not have one. Stacey Love, representing the insurer Canada Life, stated that not having a will is a significant mistake when it comes to IHT.

If someone dies without a will or the documents are incorrectly signed and witnessed, the law of intestacy dictates who inherits their estate. If there are surviving children, grandchildren, or great-grandchildren, a spouse or civil partner will get the first £270,000 of the estate and half of anything above that.

If your estate is worth more than £325,000, and you have direct descendants, they will receive the rest of your estate, but a 40% IHT charge will be applied. If you pass away without a spouse or civil partner, your estate will be divided equally among your surviving direct descendants.

A will allows you to ensure that assets are passed down most tax-efficiently.

Home is your biggest asset and could also result in the most significant tax bill:

Many people think that giving their home to their children while still living there would exempt them from Inheritance Tax (IHT). However, this is not true. According to HMRC, it is considered a "gift with reservation, " meaning you still benefit from the asset even though you've given it away. Even if you live for seven years after making the gift, the home will still be counted as part of your estate for tax purposes.

Paying market rent to the new homeowners is necessary to prevent IHT on a gifted house to your children. Ensure a rental agreement includes annual rent reviews, as HMRC may require evidence.

Record Keeping: 

If your estate may be subject to Inheritance Tax (IHT), keeping detailed records to demonstrate that it qualifies for exemption is essential. HMRC doesn't grant exemptions easily, so tax experts suggest documenting any gifts made during your lifetime. To avoid disputes with HMRC, it's best to write a letter to the beneficiary with the gift's description, value, and date.

Residence nil-rate band 

The residence nil-rate band can add an additional £175,000 to your tax-free allowance when you leave your main home to your children or grandchildren, including adopted, fostered, or stepchildren. It's a valuable allowance worth considering.

You can give away up to £500,000 tax-free with the combination of a £175,000 residence nil-rate band and a £325,000 allowance. However, the residence nil-rate band reduces by £1 for every £2 an estate is worth over £2 million.

It only applies to direct descendants, so someone leaving home to their niece, nephew, or wider family member would not qualify.

If you are married or in a civil partnership, you can combine your allowance and pass on up to £1 million tax-free if your estate includes your main home.

According to Chris Etherington from RSM UK, for someone to qualify for the relief, they typically must have owned a residential property they lived in at the time of their death. This type of property is known as a "qualifying residential interest."

If they gave their main home to their children while they were alive, the property would not qualify, and the relief maybe be lost. The same would apply if they sold their house and moved into a care home.