Do You Distrust Your Heirs More Than You Dislike HMRC?

As silly a question as that may seem it is a real statement made by former Chancellor Roy Jenkins who once described Inheritance Tax as “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”.

In reality that is reflective of how avoidable IHT is for those that decide to make a plan about it, but with HMRC raising more than £5.4bn in IHT last year alone it seems that some are either unaware of what they can do or have decided to do nothing about it.

With the current rate of UK inheritance tax being up to 40% on the value of your estate when you pass away, it can be a tough pill to swallow for your heirs … if not planned for in advance.

In this article, we look at IHT, what it might mean for you and some of the options that are available.

Does Inheritance Tax Matter to Me?

The first question to ask yourself is, does inheritance tax bother you?  Some people may have the view that IHT is a way to repay society, and whatever is left over for their heirs is what it is. Others have the view that if they can mitigate some, or all, of the liability legitimately, then they will do so.  There is no right or wrong answer, but it is sensible to be aware of your position and plan as you see fit.

Who Actually Pays UK Inheritance Tax?

In short, if you are considered UK domicile at your time of death, inheritance tax of up to 40% will be due on your worldwide estate.

Domicile is different from residence; it refers to the place which is considered your permanent home. When you are born, you automatically assume the domicile of your father as your domicile of origin. So, for those born in the UK and whose father was UK domicile and resided in the UK at your time of birth, it is highly likely that you are UK domicile.

It is possible to adopt another domicile of choice. But unless you take specific and evidenced actions to adopt another jurisdiction as your permanent home, it is unlikely that your domicile of origin will change.  For some expats this can be a real challenge and for many British expats, even those that have lived in another country for years in some cases, decades, they still find themselves – often unknowingly – UK-domiciled.

What makes it a real challenge is that the onus is on your beneficiaries to prove to HMRC that you have adopted a domicile of choice and that you were committed to remaining resident in that same nation for the indefinite future. For expats that have lived in several countries, how can it be proven that you were definitely going to remain in the one that you were living in when you died?

In the most extreme of cases HMRC has even challenged and won against the estates of those that died overseas, but that held UK burial plots, deeming this as an emotive intention of returning to the UK at some point in their lives, hence retaining their UK domicile.

NB – Due to the complexity of domicile, we would always suggest clients seek a formal opinion from a tax advisor before taking any actions.

Who else pays it?

Anyone who own UK assets, for example, property, regardless of where they live or their domicile status, will pay UK inheritance tax on those assets held in the UK.

 

So, what can you do about it?

Allowances & Exemptions

The headline figure of 40% does initially seem excessive; however, there are tax-free allowances that the government have in place to make inheritance tax less punitive, especially for those with smaller estates.

Firstly, each individual has a £325,000 ‘nil-rate band’ tax-free allowance. i.e. the first £325,000 of your estate is IHT free.

For your main residence, there may be an additional allowance of £175,000 per person (to help to remove the burden of passing on the family home). That said with the tapering of that allowance on estates of more than £2million it can easily be lost again.

Gifts between spouses for married couples and civil partnerships are also exempt, and if one person was to pass away, you can transfer any unused nil-rate band to the other person.

Pension assets and also property solely used for business purposes are not considered for inheritance tax purposes.

Gifting Over Your Lifetime

One action people can take is to reduce the value of their estate over time, so the eventual inheritance tax bill is reduced.

Your annual exemption allows you to give away £3,000 worth of gifts each tax year (6 April to 5 April)

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, payments to help with another person’s living costs (such as an elderly relative or a minor child) and gifts to charities and political parties.

After that, in any 7-year period, you can make gifts and transfer up to your £325,000 nil rate band. Gifts made 3 to 7 years before your death are taxed on a sliding scale known as ‘taper relief.’

Trust Planning

Trusts can be a very useful tool and are a type of estate planning that can be used to invest money or hold assets for the benefit of your beneficiaries in the future, instead of directly transferring ownership of the assets today.

Different types of trusts can be used for different purposes. There is generally a trade-off between control, flexibility and tax efficiency.

For example, a discretionary trust will give you flexibility over changing the beneficiaries of the trust (useful if you want to change beneficiaries from children to grandchildren), but a gift into a discretionary trust will be what is known as a ‘chargeable lifetime transfer’. This means that if the total gifted in the 7-year period exceeds the £325,000 nil-rate band, the amount exceeding will immediately be liable for IHT at a reduced rate of 20% whether you have passed away or not.

On the other hand, an absolute (or bare) trust means you have no flexibility to change the beneficiaries, but there are other reasons to use this type of structure.

Life Insurance

An issue when transferring wealth is that the inheritance tax bill has to be paid before the asset is legally passed on.

There are some cases where assets are not easily transferred, such as property, and having to fund a large inheritance tax bill could cause unnecessary distress to your beneficiaries and loved ones.

One simple solution to this is to determine what the liability would be and hold life insurance to cover this. Life insurance guarantees to pay out a lump sum assured upon death to your beneficiary so would allow them to pay any inheritance tax bill with ease.

 

Some inheritance tax may be inevitable, but there are steps you can take to ensure your estate isn’t taxed excessively and more importantly, that it isn’t worrying you on an ongoing basis. If IHT is a concern for you, taking action in good time will give you peace of mind that you pass on your estate exactly as intended.

Get in touch today if you would like to discuss this and we can help you to make a plan.

 

PLEASE NOTE COMMENTS MADE IN THIS ARTICLE SHOULD NOT BE CONSTRUED AS EITHER FINANCIAL ADVICE OR TAX ADVICE.