Helen Morrissey, head of retirement analysis, Hargreaves Lansdown: “As of this week, the clock is ticking down towards unused defined contribution pensions becoming part of your estate for inheritance tax purposes. It’s a change that has attracted a lot of attention, but it’s important not to panic - the number of estates liable for inheritance tax has grown, and will continue to grow, but they will remain in the minority so do check if it will be an issue for your family. If there is a potential looming liability, there are steps you can take to lessen its impact, though it will need careful planning.
1. Who pays inheritance tax?
If your estate is worth more than £325,000 on death then there may be inheritance tax to pay. This is known as your nil rate band. Added to this, if you pass on your family home to a direct descendant – a child or grandchild for instance - then you have a further allowance called the ‘residence nil rate band’ which is worth £175,000. For example, a single parent passing down their family home to their child could pass on up to £500,000 without the estate facing an inheritance tax bill.
If you are married or in a civil partnership, then you have further advantages. To start with, you can pass on assets of any value to your spouse/civil partner free of inheritance tax. They can also inherit any unused nil rate bands that you have. This means that a surviving spouse/civil partner can potentially pass on up to £1m on death before the estate faces an inheritance tax bill.
2. A warning for cohabiting couples.
There’s a word of warning here for cohabiting couples – they don’t enjoy the same advantages as a married couple, so are unable to benefit from inheriting assets of any amount, or their partner’s nil rate bands. This can come as a nasty shock at an already difficult time so it’s worth planning in advance as well as making sure important documentation, such as wills and expression of wish forms for pensions, are updated and maintained.
3. You can gift now rather than later.
Giving away assets while you are alive means you can help people reach their financial goals that bit sooner. It’s also fascinating to see what someone does with the money, which may affect whether you give more money to them in future.
There are various allowances you can make use of to reduce the value of your estate. You can gift any amount of money to a loved one and it will fall out of your estate for inheritance tax purposes after seven years. These are known as Potentially Exempt Transfers (PET). If you die within that time, inheritance tax may need to be paid, though potentially at a reduced rate.
There are also allowances that will take money out of your estate for inheritance tax purposes immediately. For instance, you can make use of your £3,000 annual allowance to gift to loved ones. You can also gift up to £250 to any number of recipients but you can’t gift this to someone who you have also made a gift to using another allowance – doing so would mean part of the gift would be classed as a PET, and you’d have to live for seven years after giving it for it to become IHT-free.
There are also allowances that can be used when a loved one gets married. You can give up to £5,000 to a child, £2,500 to grandchildren and great grandchildren and £1,000 to anyone else. These gifts need to be made on or before the wedding, and the wedding does need to go ahead!
Gifts to charities and political parties can also be made inheritance tax free. On death, if you gift at least 10% of your net estate to a UK registered charity, you will also see the rate of IHT you pay on your remaining estate will drop.
Another important rule is what is known as ‘gifting out of surplus income’. You can give away any amount, and it comes out of your estate for IHT purposes immediately. However, there are rules. The gift needs to come from income, not capital. It needs to be made on a regular basis, and it must not affect your standard of living. Examples of this could include paying school fees for a grandchild or contributing to a Junior ISA.
4. Be careful!
As with all gifting, you must make careful notes of what you have given to who and when. This will help your loved ones evidence what you have done if needed. It’s a good idea to get help from a financial adviser to make sure you stay on the right side of the rules.
You also need to make sure that when you gift something away then that is what you are doing. So, for instance, if you were to gift your home away to a loved one but continue to live in it rent- free then it could be seen as a gift with reservation – i.e. you are still benefiting from it. If this is the case, then your estate could be landed with a bill.
Trusts can also be used as part of an inheritance tax strategy, but this can be complex and your estate could still end up with an inheritance bill. It’s important to take financial advice so you understand your options before going down this route.
5. Look after yourself first.
It’s important not to give away too much too early. None of us know how long we are going to live and you don’t want to be in a position where you are running out of money because you’ve given too much away. You also need to take account of potential care bills later down the line which can take huge chunks out of your savings.”
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