September 25, 2019 by Jen Wiss-Carline
Inheritance tax is primarily a charge made on your assets at the time of your death. However, in addition:
Not all gifts will result in an inheritance tax charge as there are various allowances that can be used.
The main inheritance tax allowance is £325,000 – this is called the ‘nil rate band’. No inheritance tax is payable on assets you own at the time of your death up to this value. This rate will be in force until at least 5 April 2021.
In addition, you have a ‘Residence Nil Rate Band’ (RNRB). This can be used where you give property in your Will to a direct descendant (for example, a child or grandchild).
Currently the RNRB is £150,000 (2019/20 tax year). It will increase to £175,000 in the 2020/21 tax year.
Each person therefore has an allowance of up to £475,000 on which they will pay no inheritance tax (depending on how much of the RNRB they are able to use).
Inheritance tax is charged at 40% on anything over this amount.
To take advantage of the Residence Nil Rate Band (RNRB) which came into force 6th April 2017, it is necessary to leave your home to a direct descendant. A direct descendant includes a child, grandchild, adopted, step or foster child, and the spouse or civil partner of each of those beneficiaries.
In addition, if you downsize or sell up before death, the RNRB may still be available.
However, if your estate is worth more than £2 million, the allowance is tapered. As a result, estates worth £2.2 million or more will not benefit from the RNRB.
Assets left in a Will to a spouse or civil partner are not subject to inheritance tax, regardless of their value. So for example, if a husband leaves his wife his whole estate worth £500,000, no tax is charged on his death.
In addition, because he did not use 100% of his inheritance tax allowances, his wife’s estate will benefit from a 100% increase on the nil rate band allowance applicable at the time of her death plus 100% uplift on whatever Residence Nil Rate Band is in force at the time of her death.
Potentially, therefore, a husband and wife can pass on £950,000 to their children, free from inheritance tax (£1 million from 2019/20 tax year).
Care should be taken however – leaving your entire estate outright to a spouse has its risks which we will discuss later.
Gifts made to charity are not subject to inheritance tax. In addition, if you give 10% of your net estate to charity, any Inheritance Tax payable is reduced from 40% to 36%. Of course, this saving will only be useful if the value of your estate exceeds your nil rate band and Residence Nil Rate Band.
If you have business or agricultural assets that you leave in your Will, inheritance tax relief may be available. Business property relief and Agricultural property relief both work to notionally reduce the value of the asset by a percentage.
For business property, that percentage is 100% for:
(a) a business, or an interest in a business (such as a share in a partnership); and
(b) unquoted shares.
Or 50% for:
(a) quoted shares which gave the transferor control of the company; and
(b) certain land, buildings and machinery owned by the transferor but used by their company or partnership.
Agricultural property relief is available where property must have been owned and occupied for agricultural purposes immediately before its transfer for:
The rate is either 50% or 100% depending on circumstances.
Some property does not ‘count’ when calculating inheritance tax because it does not actually fall into your estate. One of the most common examples is life assurance policies where these are written in trust for a named beneficiary. Where this is the case, the proceeds are payable directly to that person, not to your estate.
Another example is a pension fund where the pension trustees can make a discretionary lump sum payment to a person of their choosing. Usually you would leave a Nomination of Benefits Letter to say who you’d like to receive the money – but the trustees do not have to follow your wishes. For example, if at the time of your death you were married with children but you had failed to update your Letter for many years which nominated a former girlfriend, there is a good chance the trustees would pay out to your spouse!
Some property is classed as excluded and does not affect the inheritance tax position. The most common example is ‘an interest in remainder’ that follows a ‘qualifying life interest’.
In 2005, William puts Rose Cottage in trust for George for life, remainder to Charlotte.
While George is still alive, Charlotte has an ‘interest in remainder’. Assume that Charlotte already owns a lot of property which takes her over the nil rate band/RNRB. If she gives her interest in remainder to Louis while George is still alive (i.e. before the cottage comes to her), there will be no Inheritance Tax implications and no Capital Gains Tax either.
Trusts can ensure your assets go to your intended beneficiaries rather than passing outside of the family.
Many people choose to create a trust in their Will rather than an outright gift. They will choose trustees to manage the trust and look after the interests of the beneficiaries.
The main types of trust are:
With this type of trust, you can leave the benefit of an asset to one person for life, with the remainder to another person.
Why is this type of trust attractive? Because it preserves the asset and keeps it in the family – whatever happens to your spouse, the asset is safe for your children.
Compare this to a Mirror Will where you leave everything to your spouse, then the children:
As you can see, Mirror Wills have a lot of risks. These are just some examples of why creating a life interest in your Will is a good idea.
For inheritance tax purposes, the ‘life tenant’ – the person who has use of the asset during their lifetime – is treated as owning it. When they die it is counted as part of their estate when tax is calculated.
Discretionary trusts allow the trustees to distribute to a class of beneficiaries. For example, you might specify that your brother and sister will be trustees and your three children will be the beneficiaries.
The huge benefit is their flexibility – you cannot possibly know what the circumstances of your children or grandchildren will be on your death. One child may be doing particularly well while another has very little – and an equal split in these circumstances may be unfair. Likewise, if they are just going through a divorce, the last thing you want is for your hard earned wealth to form a part of their divorce proceedings.
The downside often quoted is taxation. They can be subject to 10 year anniversary and exit charges, together with unfavourable income tax charges. However, to dismiss them on this basis ignores a huge opportunity that they present.
First, the very nature of a discretionary trust is that no beneficiary is absolutely entitled to the assets it contains. If at the time of your death your children are going through a divorce or find themselves in financial difficulty, the trust assets are not at risk.
Second, if you create a discretionary trust that allows your trustees to set up further trusts, they can make all the decisions as to how the assets are disposed of within the first 2 years following your death. This means they can take all of your beneficiaries circumstances into account at that point and make decisions that are tax efficient and best preserve your wealth.
They may decide to:
In all of these scenarios, the decision is ‘written back’ into your Will as if you made it yourself, taking advantage of any inheritance tax allowances and exemptions that this brings. You can of course leave a Letter of Wishes guiding your trustees on how you would like them to act.
Of course, this may require a little legal help later on, but that minor inconvenience pales in comparison with how much can be lost to care fees, ex-spouses or creditors if an asset is inherited outright at the wrong time.
NB: A discretionary trust can be combined with a life interest – so you can leave a life interest to your spouse with the remainder to your children on a discretionary trust that allows the trustees to create more trusts as they see fit.
With this type of trust, your beneficiary is entitled to the asset but the trustee holds it for them. This might happen if you gift something to a minor.
Some trusts for minors have beneficial tax treatment
Will trusts for minors may be:
You can find out more about Will trusts for minors here. Some of these trusts have substantial tax advantages such as not being subject to the 10 year anniversary or exit charges (or paying a heavily reduced rate). However. the choice of trust must take all other factors into consideration, including the age at which the child should inherit, what happens to the income before they inherit and whether you want the child to be deemed to own the assets before they inherit them.
One view is that rather than choosing the type of trust that would be beneficial now, you should leave the decision to your trustees (i.e. create a discretionary trust with the power to create further trusts). As noted above, any decisions they make within the first 2 years can be ‘written back’ as if you made the decision yourself. This allows them to decide what to do based on your beneficiary’s circumstances. Clearly your choice of trustees is very important if you decide to go down this route.
With proper estate planning, you can minimise the amount of inheritance tax that is paid on your death and preserve your assets for future generations. It is essential to review your Will and the value of your assets regularly – at least every 3 years and after any significant change of circumstances (see: ‘Do I need to change my Will’) April King offer a free 1 hour appointment with one of our lawyers, and we also offer home visits. Get in touch to book at a time and location convenient to you.
Disclaimer: This article is intended to be a general overview of inheritance tax. It is not a substitute for professional advice on your individual circumstances.
Jen was admitted as a Chartered Legal Executive in 2006. She advises on a range of matters for families, individuals and directors/partners. She has contributed extensively to various legal blogs and publications, including LexisPSL and the Legal Executive Journal, in addition to providing commentary for the Law Gazette. She holds a Masters in Law with Distinction and was Highly Commended by CILEX in 2018 for her private client expertise.
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