Estate planning is a grand term for simply passing on your assets after passing away. However, this isn’t without justification, because the process can sometimes be tricky to get right.
The importance of protecting family wealth and passing it on doesn’t need to be stressed - it’s core to our human nature. In fact, this can often be central to the idea of how wealth and richness differ. Whilst richness revolves around materialism and income (in other words, a lot of spending), wealth is about assets, trusts, and strategies that are built to last for generations.
The more wealth you have, the more important estate planning becomes. This article aims to explain what can go wrong when estate planning is not done correctly, along with some basic principles of inheritance tax.
The Pitfalls of Poor Estate Planning
Passing on wealth used to be a lot simpler than it is today, and there are a few reasons behind this. Whilst the passing on of wealth typically used to take place when someone passed away, today there’s a lot more going on.
Firstly, family relations are more complex than ever before. Divorce is normalised and reasonably common, whilst family members are now more likely to live in different countries. Furthermore, life expectancy has doubled since the 19th century despite a rise in the early retirement movement, meaning there can sometimes be two generations retiring in tandem.
Another issue which is not immediately obvious is when you pass and your spouse remarries, without correct planning the new partner would own 50% of all assets potentially leaving your children with nothing. This should not be overlooked!
The major threat to our estate when passing it on is inheritance tax. This is a tax on the estate of the deceased person as it changes hands.
Normally, there is no inheritance tax if the estate value is below the £325,000 threshold or if everything you leave above this threshold amount is left to your “spouse, civil partner, charity, or community amateur sports club”. You likely need to report the estate’s value regardless, but you also get to share unused threshold amounts with your spouse/civil partner.
Should you have a £1 million equities portfolio and a £325,000 home, it’s possible that you may be required to pay 40% on the passing down of your portfolio - a disastrous £400,000 tax bill.
Current Inheritance Tax Rates
The standard Inheritance Tax rate is 40%. This is a lot, but fortunately, it works a little bit like income tax in that you only pay tax on the amount that exceeds the threshold. Though, with no planning, this bill can be vast for high net-worth individuals.
The true devastation of inheritance tax comes from the fact that it must be paid before the probate is issued. In fact, the current guidelines state that you will get a grant of probate within 8 weeks of sending the original documents. It can often create a catch-22 situation, though it is often possible to make staged payments.
The particularly pernicious quality of inheritance tax is that it can sting twice - and in a short space of time. Not only do we pay income and capital gains tax on our assets for them to be taxed again upon inheritance, but inheritance tax becomes payable again at 40% should the beneficiary pass away as well.
If your estate is worth £500,000 and your tax-free threshold is £325,000, the inheritance tax charged might be 40% of £175,000 (£500,000 minus £325,000).
Residence Nil-Rate Band
Confusingly, there isn’t just one inheritance tax allowance per se. The £325,000 is a great start, but we can do better. The Residence nil-rate band (RNRB) is an additional allowance of £175,000 on top of the £325,000, totaling £500,000.
Similar criteria apply to this allowance. The person who passed away must have owned a property which was their main residence, and the property must have passed down to a “direct descendent” (i.e. children, stepchildren and grandchildren - not nephews and distant relatives) - this is where oversight can occur. The value of the estate must be below the standard £2 million amount, but some tapered allowance may count for estates greater than £2 million.
In other words, inheritance tax may not be due on the first £500,000 of the estate. But, because you can pass on unused allowance to a spouse or civil partner, it’s possible that a residential home of up to £1 million can be tax-free (£500,000 allowance + £500,000 allowance).
Ideas To Cut Your Inheritance Tax Bill
Cutting your inheritance tax can be complicated, particularly with larger estates, which is why it’s recommended to seek bespoke guidance. However, here are some general ideas to consider when looking at cutting your tax bill.
- Gifts - It may be possible to give some of your money away as a gift without paying taxes. The general rule here is that it will be tax-free as long as you live seven years after giving the gift away. This is one example of estate planning (far ahead) being important.
- Other gifts - Besides the above, it’s possible to give away £3,000 each tax year without incurring any tax. This allowance can be carried over one year, but no more.
- Weddings - If a close relative has a wedding coming up, you can give certain amounts (depending on who they are) without any tax.
- Charities - Gifting to charities can be tax-free
- University payments - A big part of passing on wealth is ensuring your children’s future - what better way to do this than by paying for their education ahead of time? This will certainly be tax-free as it’s a simple expenditure and has no limit.
- Business Relief - It may be possible to get Business Relief of 50% or 100% on some of the estate’s business assets.
For those that have generated substantial wealth beyond the simple allowance threshold amounts, inheritance could become a disastrous problem. In difficult times of losing a loved one, the last thing you need is more stress.
Thomas Kelly Holdings can provide comprehensive information and expert guidance in the complicated area of estate planning. Our goal is to plan ahead of time and efficiently plan your tax minimisation using a wide range of techniques, including Wills, Trusts, Lasting Powers of Attorney and all areas of estate planning.
Thomas Kelly Holdings do not provide Tax, Legal or Investment Advice.