Reduce your Tax - Lowering Inheritance Tax
There are a few ways to reduce tax or improve your tax position. Please take time to read through the following section to get ideas as to what you can do in your own circumstances.
May we suggest you read the following sections on exemptions to get an idea of what can be included and excluded before exploring the various ways that you can protect assets.
1. Use Your Personal Inheritance Tax Exemptions
Within certain limits gifts to the bride and groom are exempt from Inheritance Tax.
The gift needs to be made on or before the date of the wedding and can be used as part of a larger gift.
2. Give Some of Your Personal Assets Away
By giving some of your personal assets away you are making what is known as a transfer of value which reduces the value of your estate.
The technical term is a lifetime transfer.
These transfers of value may be lifetime gifts between individuals, gifts into trust or bequests under a Will.
Do not give too much away - you may get taxed
Some lifetime gifts are treated as potentially exempt transfers PETs and no tax arises at the time the transfer is made.
However, if you die within 7 years, the potentially exempt transfer PET becomes a chargeable transfer and Inheritance Tax may then become payable if they are in excess of the nil rate tax band value.
Chargeable transfers above this are taxed in their own right (and not a potentially exempt transfer which then becomes chargeable) attract tax at half of the normal rate of Inheritance Tax i.e. 20%.
Chargeable transfers that are taxable immediately are normally gifts to discretionary trusts, interest in possession trusts, accumulation and maintenance trusts and gifts to companies.
3. Use Your Will to Use up Your Nil Rate Tax Allowance
Do Not Just Postpone the Tax
If you are married or civil partners and have made Wills you may have stated that you wish to leave all of your assets to each other.
As transfers of assets between legal partners are exempt from Inheritance Tax, it means that no tax will be due on the first of the legal partners to die anyway.
This means you do not use one of your nil rate tax allowances at first death. However, it is not lost as you can now combine unused allowances on second death; in simple terms a husband and wife or civil partners can 'carry over' any unused nil rate tax allowances.
Whilst it is not technically wasted for inheritance tax planning, we suggest this could be a wasted use of the allowance when considering care fees planning.
Use Both Allowances With Your Wills:
If, in your Will, you each leave assets to people e.g. children or a trust, other than your spouse or civil partner, on your death those assets would pass to those people or trusts, thereby reducing your estate.
This means that the first part of your family wealth is protected from any potential future means tested care fees of the surviving partner.
It is better for the family to have a choice of paying additional care fees rather than all the estate being only by the surviving spouse and automatically included in any care fees assessment.
1st Death - 1st Allowance Used
As an example, if you intend to eventually pass all of your assets onto your children, if it is affordable, some could be given directly on the first death, rather than leaving it until the second death. By using part or all of your nil rate band on death you are thereby reducing the value of your estate, and reducing the care fees assessment risk.
2nd Death - 2nd Allowance Used
The estate is lower already as part has either been gifted to family, friends or a trust and you use up the second Nil Rate Tax Allowance on death. In short, the same inheritance tax bill may be due as both allowances are used either way, but much if the estate may have been protected from care fees assessments on second death.
Over £325,000.00 Saved (even more if you also use the Residence Nil Rate Band too of £175,000:
This has a dramatic effect of potentially protecting in excess of £325,000.00 + £175,000 from a care fees assessment on the surviving partner with a simple clause in your Will.
Better Late Than Never:
If your partner has passed away you may consider using a Deed of Variation, this can technically vary a Will and create the use of the nil rate allowance even if you had not included it in the original Will.
4. Use A Deed Of Variation To Use Up Unused Allowances On Death
If you have been left money in a Will and you do not want it or need it or you wish to save Inheritance Tax then a Deed of Variation may be the answer.
For example, if you are married or civil partners and your partner passes away and leaves all their assets to you they have wasted their nil rate tax allowance.
Roll Back The Clock:
You can vary a Will by using a Deed of Variation
Provided the sole beneficiary or group of beneficiaries of an estate all agree, the distribution of the estate can be changed.
In simple terms a Will can be varied after death, to enable you to technically go back in time and change the beneficiaries.
This is a very powerful inheritance tax planning tool.
A Deed of Variation Has To Be Done Within 2 Years Of Death.
5. Put Your Investments in Trust
Investments that you do not draw an income from and that you intend to pass to your children or others on your death, can either be:
Passed to them in life or via Will on death to use your nil rate allowance
A lifetime transfer of this type will be classed as a potentially exempt transfer and you must survive seven years from the date the policy is put into trust for them to be fully moved outside your estate and be disregarded in the calculation of Inheritance Tax.
If you do not survive for seven years, part of the investment in trust may be included in your estate.
Put in Trust:
Trust - put into a trust when the investment is started or even afterwards.
There are many simple trust vehicles that are used for investment purposes and each has its own advantages:
There are many other trust types explained in the trusts section.
6. Give To Charity Reduce Your Inheritance Tax Liability
Gifts to charity, whether during your lifetime or through a wish expressed in your Will are exempt from Inheritance Tax.
7. Give To Political Parties Reduce Your Inheritance Tax Liability
Well, there is a surprise for you!
Gifts to political parties, whether during your lifetime or through a wish expressed in your Will are exempt from Inheritance Tax.
8. Make Maximum Chargeable Lifetime Transfers or Gifts Up To The Nil Rate Band
Make as many chargeable lifetime gifts as you can but only up to the nil rate tax threshold.
Do not exceed the threshold because excess gifts would be immediately chargeable to inheritance tax.
After 7 years the gift falls outside the estate and is not taxable on death.
9. Make Maximum Potentially Exempt Transfers PETs or Gifts Up To The Nil Rate Band
Make as many potentially exempt transfers gifts as you can, up to and even over the nil rate tax threshold.
Gifts are not immediately chargeable to inheritance tax.
After 7 years the gift falls outside the estate and is not taxable on death.
10. Change to Tenants in Common and Will Your Share Of the Home
For couples or people with few assets to pass to their children or others, apart from their home, Inheritance Tax planning and care fees planning can still have a large impact.
You should make use of allowances as early as possible to avoid potential care fees means testing of assets.
Two types of property ownership
It is helpful to understand that there are two types of property ownership under English law: legal ownership and what is known as beneficial or equitable ownership.
Legal ownership - The people named on the title documents are the legal owners. The legal owners are the people listed as the "registered proprietors" in the proprietorship register at the Land Registry. However, legal ownership is not significant.
Beneficial ownership - the right to live in and use the property and the right to share in the proceeds of any sale. Beneficial owners are the ones who have the power to control a sale or not. This is the valuable part of ownership.
Most people own their property as legal and beneficial owners.
Tenants in Common or Joint Tenants
In general, property can be held:
Tenants in Common and Gift Your Property Share On Death:
A common approach is to change the ownership of the property for a couple to tenants in common. Your then each own your own share of the property.
You then make changes to your Will and bequeath your half of the property to your family on death. This can ensure you use your nil rate tax allowance on first death to potentially reduce care fees planning issues.
Provided you have careful provisions drafted in your Will to allow for market rent to be paid, their should be now liability to Pre Owned Assets Tax.
This may create Capital Gains Tax problems for the family as second home owners.
Tenants in Common or Joint Tenants, Gift Your Property and Pay A Rent:
It is also possible to gift the family home away to family and still live there.
However, unless the person(s) who made the gift pays a full market rent for still living in the property, the gift could be treated as a 'gift with reservation' and be subject to Pre Owned Assets Tax.
It could also be argued that the person giving the property had an 'interest in possession' which would make it ineffective for Inheritance Tax planning purposes.
Again, this may create Capital Gains Tax problems for the family as second home owners.
Consider Equity Release:
There are plans available which are generally designed to offer people with low income or no capital the ability to generate income from the value of their homes. These are known as Home Income Plans and can be advantageous in terms of planning for Inheritance Tax as well as generating income and/or capital by reducing the value of the property yet making capital or income available to spend, invest or for some tax planning as you see fit.
11. Borrow Money on Assets Overseas
Inheritance Tax is charged on the worldwide assets of individuals that are domiciled in the United Kingdom, wherever they are resident.
Individuals domiciled outside the United Kingdom are subject to Inheritance Tax in respect of assets situated in the United Kingdom such as a house, whether resident in the United Kingdom or not.
UK Resident and Domiciled UK:
Overseas Property: If you are domiciled in the United Kingdom, the value of your holiday home would be included in the calculation for Inheritance Tax in the UK less any taxes due where the property is situated.
You need to investigate the tax rates and liabilities in the country where the property is based. If the tax rates are higher than the UK or the rules on using trusts are not available, you may consider raising a loan or mortgage secured against the property for the greatest amount possible. This would have the effect of reducing the value of assets in that country and therefore the Inheritance tax liability. You may wish to consider information offered in the International Channels.
UK Resident for Non Domiciled UK:
UK Property: Consider raising a loan or mortgage secured in the UK against the property in the UK, for any value in excess of the nil rate tax allowance. This has an immediate effect of reducing your tax liability in the UK. Consider also changing ownership of property to tenants in common.
Overseas Property: Will be taxed where the property is based and/or where you are domiciled.
This will not necessarily mean that you are not taxed in other countries where you may be deemed domicile.
12. Paying Into Pensions Can Reduce Inheritance Tax Liabilities
If your pension scheme, is classed by HM Revenue and Customs as 'Exempt Approved”, which is virtually every single pension scheme in the UK, then any benefits, including lump sum benefits payable on your death may be free of taxes.
Death Before Retirement: (below age 75)
In this context, before retirement means not having taken any tax free cash and/or income from the pension.
The Fund Can Be Paid Out As Lump Sum - Your estate will receive 100% of the value of the pension fund subject to a maximum of the pensions Lifetime Allowance with no tax liability. If the pension fund is bigger than the Lifetime Allowance, the excess will be subject to a tax charge of 55%.
The Fund Can Be Paid Out As Income To Dependents - There will no be tax charge or assessment as above although the dependent will receive the pension income paid out subject to normal income tax assessment and deduction.
Death After Retirement: (below age 75) Potential Tax Charge 35%
In the context, this means having taken either a tax free cash sum and/or income from the pension.
If the pension income is still unsecured i.e. an annuity income has not been obtained yet.
Your estate will receive 100% of the value of the pension fund subject to a tax charge deduction of 35%, this is lower than the current Inheritance tax rate of 40%).
Death and over 75
If the pension income is Alternatively Secured Income at the time of death (i.e. over age 75 and the policyholder has not purchased a guaranteed annuity with the fund but is still drawing from the fund at a reduced rate, the fund must either:
You may as well take a chance:
If you are committed to reducing your inheritance tax liability, then you may as well take a chance with pension contributions. If you die before 75, then there is no tax to pay, if you die after this there may be.
13. Using Trusts
Trusts can be excellent for inheritance tax planning and mitigation.
We suggest the use of the following trusts can be used effectively to suit different needs and reduce your tax liabilities:
Life Cover Trusts: If you wish to set up a simple life insurance policy for the value of the inheritance tax liability. The benefit can be placed in trust for your beneficiaries. On death, the proceeds are paid out to them free of taxes and these monies can be used to settle the liability.
Absolute - Bare Trusts: Can be used in connection with the life insurance policies or for placing investments in trust. For investments in the trust, they are a potentially exempt transfers PET and are free of the estate and inheritance taxes after 7 years. Any growth on the investment is outside the estate from day 1. The beneficiaries on these trusts cannot be changed. This means that there is no charge periodic tax charge every ten years or an exit charge.
Flexible Trusts - Interest in Possession: Can be used in connection with the life insurance policies or for placing investments in trust. The beneficiaries on these trusts can be changed. This means that there is a periodic tax charge every ten years and an exit charge. For investments in the trust, they are not potentially exempt transfers PET. This means investments into the trusts are chargeable lifetime transfers and are free of inheritance tax provided you do not exceed the nil rate tax threshold and then they fall outside the estate on death for inheritance taxes after 7 years. Any growth on the investment is outside the estate from day 1. There will still remain the periodic tax charge every 10 years.
Discretionary Trust: Discretionary trusts are similar to flexible trusts for taxation. In fact it was flexible trusts that were brought into line with Discretionary trusts. They are not potentially exempt transfers PET. This means investments into the trusts are chargeable lifetime transfers and are free of inheritance tax provided you do not exceed the nil rate tax threshold and then they fall outside the estate on death for inheritance taxes after 7 years. Any growth on the investment is outside the estate from day 1. There will still remain the periodic tax charge every 10 years. These trusts generally remain outside the control or ownership of the family or next generation permanently. Any income or growth is paid to the potential beneficiaries, including the person who set up the trust at the discretion of the trustees. These trusts protect assets from creditors, will not form part of the generations to come estates for inheritance tax purposes, but will suffer the 10 year periodic charge.
Disabled Trust: These trusts are specifically for disabled people or those who expect to become disabled in the future by nature of a debilitating illness. Monies transferred into trust are potentially exempt transfers PET and are free of the estate and inheritance taxes after 7 years. Any growth on the investment is outside the estate from day 1.
Discounted Gift Trust: A simple and effective way to reduce the value of your investments immediately, on day 1 for inheritance tax purposes by around 40%-60% and still retain options to access 100% of the income from the whole investment. Your beneficiaries inherit 100% of the original investment plus any growth on the investment.
Inheritance Loan Trust: A simple arrangement whereby you retain access to your capital at all times and any growth on your investment is outside your estate for inheritance tax purposes. The growth is in trust for your beneficiaries.