How to shield your estate from inheritance tax

by | Aug 27, 2021 | Tax

For the Treasury, inheritance tax (IHT) is not the largest cash cow that it will rely on as the UK begins its road to recovery. It equates to only 0.25% of GDP in 2017/18. By comparison, the amount brought in by income tax in the same period equated to 8.7% of GDP.

But with inheritance tax collecting £5.33 billion in 2020/21, the second highest amount since the £5.36bn collected in 2018/19, an estimated 33,000 people are expected to have taken a hit this year, up by almost a third from last year.

The tragic rise in deaths related to COVID-19, the booming house market and a five year freeze in tax protections announced at the March Budget, are between them responsible for the increase in IHT receipts. 

And with the IHT haul expecting to reach an all-time high of £6bn next year as well, now is the time to review your estate and taxstrategy.

Put your money into a trust

Let’s start with a method to reduce the tax bill on your estate that some people are anxious about: putting money into a trust. There isn’t much reason to be nervous, though, as trusts are easy to maintain and can deliver great benefits. 

A trust is a legal agreement in which you place money, property and investments into the responsibility of a trustee. They’ll look after your assets for your beneficiary – the person you want them to go to upon your death.

There are different types of trust, deciding things like whether the beneficiary will get trust money in a lump sum or in instalments, but what’s most important to know is how they are taxed.

Without one, anything in your estate over your £325,000 tax-free allowance will be subject to a 40% charge. In a trust, the tax is cut in half to just 20%. 

Every 10 years thereafter, your trust will be taxed by 6%, so while you will have to be careful with this approach, get it right and you stand to pass on more than otherwise to your loved ones.

Inheritance tax gift rule

Misunderstandings of this rule have cost hundreds of taxpayers £624m over the past five years as they made 1,830 gifts which were meant to be tax-free but turned out to have broken IHT rules. 

With each ineligible gift costing a mean average of £177,049, it’s clear how getting this rule right can reduce your IHT obligations.

First, gifts can be given tax-free as long as the giver lives for at least the next seven years after it’s been made.

It also has to be an outright gift. That means, you cannot continue to live in a property that you just gifted your child without paying them rent, for instance. And that rent must be at current market rates, not a token subsidised amount.

The idea is that a gift is an asset you not only relinquish ownership of on paper, but also relinquish any benefit from.

So, when it comes to staggering dispersal of your possessions years before you pass away, make sure you abide by the rules to keep your tax bill down.

Donating to charity

Just like gifts you leave to your partner or children, parts of your estate that you leave to charity are also exempt from IHT.

This can be especially useful for minimising IHT charges if your estate is worth just over the £325,000 IHT allowance, as giving the difference between your total estate and the allowance to charity can sometimes be cheaper than paying the tax.

Alternatively, if you leave more than 10% of your estate to charity, the IHT tax rate you pay will reduce from 40% to 36%.

So, if your estate was worth £525,000, your net estate would be £200,000 (£525,000 minus your £325,000 allowance). 

If you left £20,000 to charity, you would pay the 36% IHT rate, in which case your tax bill would be £64,800. In comparison, if you didn’t leave 10% of your estate to charity, your bill would be £80,000.

These are just a couple of ways that you can reduce your IHT payments to ensure you pass on as much as you can to your family once you’re gone.

Get in touch with us at 01525 88 72 77 or by filling out a contact form to discuss other ways to reduce your IHT obligations.

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