Paying tax is an unpopular pastime for most individuals. Yet the majority of people do little to avoid inheritance tax (IHT) due when they are no longer around. A new study revealed that 78% of people have no estate planning strategy in place, while 66% rarely or never discuss inheritance with their children.
The Family and Finances report, by Schroders Personal Wealth, shows that most over-60s plan to pass on their wealth to their children after death (72%), with just 13% saying they would do so during their lifetime.
Yet giving away assets during your lifetime is a very simple way of reducing your estate for inheritance tax purposes – and providing a much-needed boost to grown-up children moving up the property ladder or even to grandchildren saving for their first home.
Understanding how to pass on wealth in the most tax-efficient manner can reduce the amount that HM Revenue & Customs (HMRC) can claim when it eventually comes to assessing IHT. Here are eight ways to protect your wealth.
1. Cash giveaways
An ‘annual exemption’ allows individuals to give financial gifts, tax-free, to the value of £3,000 without them being added to the value of your estate. You could decide to pay the £3,000 into a Junior ISA for grandchildren each year.
Calculations by AJ Bell show that contributing the sum for the 18 years from birth, would result in a pot worth £87,664 tax, at 5% growth after fees – and £100,000 by the age of 21, and a £144,383 pot by the age of 28. This money could go a long way to helping the mounting challenge young people face of getting on to the housing ladder and paying for tuition fees.
If you haven’t used this annual exemption during the previous tax year it can be carried over into the next tax year. You can also give £250 to any number of people every year, but you cannot combine it with your annual £3,000 exemption.
2. Passing wealth between couples
Married couples and civil partners can inherit their spouse’s entire estate tax free and pass on any of their unused allowance to their partner, effectively doubling the tax-free limit for couples to £650,000.
3. Giving away unlimited assets
You can give away all types of assets, including cash, property and shares tax-free, as long as you live for seven years after making the gift. Crucially, this so-called ‘Potentially Exempt Transfer’ (PET) has to be an outright gift from which you can no longer benefit.
4. Gifts from income
There is a way of giving away unlimited cash without falling foul of the seven-year rule – as long as it’s from surplus income and doesn’t reduce your standard of living or force you to dip into your capital to cover day-to-day costs.
5. Handing down property
Parents can pass on a home worth £1million to family tax-free. The ‘main residence nil-rate band’ adds another £175,000 each to the normal tax-free threshold of £325,000 each. This gives couples a maximum total exemption of £1 million.
Only direct descendants are eligible, including children, grandchildren, great grandchildren and adopted, step and foster children.
If a couple’s estate is worth more than £2 million, however, the additional nil-rate band is tapered back down by £1 for every £2 over the £2 million threshold.
6. Setting up a trust
There are a number of trusts that mitigate inheritance tax. They are useful for setting aside a sum of money to be used at a later stage, perhaps where grandchildren are still young. Specialist advice is crucial to ensure the right trust is chosen for your particular needs and goals.
7. Tax-free pension giveaway
A defined contribution scheme can be passed on tax-free if you die before age 75 to children or grandchildren, free of IHT. Over the age of 75, your pension provider will deduct income tax from anything they take. The important thing is that you must remember to nominate who should benefit through the pension provider.
8. Make a Will
Making a Will ensures your financial plans are signed and sealed. Updating your Will is just as important. You can include a Will trust which allows you to make provisos on any assets left to heirs.
TOP TIP: Record-keeping is key
It is crucial to keep a written record of all the gifts made and who received them. This is particularly true when giving away surplus income. A paper trail with details of your income and expenditure will be vital for your executors to prove that the money given away was funds you didn’t need.