If we consider the legacy we will leave when we die, we are likely to focus on the positives. We may have made our mark on the world through our career, supported charities, brought up happy children and even saved or invested money to safeguard their financial security. Far less welcome to contemplate, but equally important to consider, is the legacy our beneficiaries will inherit in terms of tax.
We take a look at what you need to know about inheritance tax (IHT) – and crucially, how you can make arrangements to ensure your hard-earned assets find their way to your loved ones, and not into the taxman’s pocket.
Love and Marriage
You may ask what marriage has to do with a tax which only comes into play in the event of your death. The answer is – everything. Too much, in fact, in the opinion of some experts.
It goes like this. Everyone is entitled to pass on a certain amount of the overall value of their estate free of inheritance tax, on their death. This is called the nil-rate band, and currently stands at £325,000. You are entitled to this regardless of your marital status. So far, so good.
However, if you are unmarried, and you die, your partner will be charged IHT at 40 percent on anything over the £325,000 nil-rate band. If you were married, your spouse would benefit from something called ‘spousal transfer’, which states that transfers of property between spouses are not liable to IHT. Not only would this bring immediate benefits for the spouse, it also has positive implications for the beneficiaries of their estate when the spouse dies themselves. Because the nil-rate band is transferrable between spouses, the children or beneficiaries of a married couple who have both died are able to apply the unused nil-rate band for both spouses, which would currently make them eligible to inherit up to £650,000 tax-free.
David Smith, Head of Private Client Services at Sweeney Miller, says that current legislation favours those who choose to marry. ‘IHT is set up to favour married couples,’ says David. ‘If you have a couple who are unmarried and one of them is significantly wealthy and dies first, then potentially the family home has to be sold to cover the inheritance tax bill. The surviving partner can be put in a very difficult position because of the inheritance tax liability. It’s a clear example of how current IHT legislation works against unmarried couples.’
With the Office for National Statistics revealing that marriage rates are at their lowest level on record, we may well query whether tax law as it stands is fit for purpose.
‘There is a mismatch between tax legislation and society,’ agrees David. ‘Because of this disjunct, people have more issues with regard to inheritance tax than they would have had 30 years ago when the majority of the population got married and had children – and stayed married too.’
Rachael Leathley, Solicitor at Hay & Kilner Law Firm also acknowledges that ‘obviously current inheritance tax legislation disadvantages cohabitees’. There are no signs of the outlook improving for unmarried couples and their families, as the same issues apply to new legislation relating to the inheritance of property, introduced in April last year. This is called the residence nil-rate band.
Home Sweet Home
‘In layman’s terms,’ explains Rachael ‘if you leave your property to a child or a direct lineal descendant, then you can benefit from an additional amount of money that can pass free of IHT, called the residence nil-rate band. So if you leave your home to a child, stepchild or grandchild, then potentially you can benefit from this amount in addition to your other allowances.’
The catch lies in the fact that, just like the standard nil-rate band, the residence nil-rate band is only transferrable between spouses, leaving the children of unmarried couples at a disadvantage when they come to inherit their parents’ estate.
It may, nevertheless, be worth shelving any thoughts of downsizing, until you have had a chat with your solicitor about whether your family could stand to benefit from the residence nil-rate band, if you passed your property down to them on your death. Home may be where the heart is, but this could be an occasion where being ruled by your head could be a positive.
Doing the maths, if you are married with children, and have a substantial property in the family, your children could inherit up to £650,000 of your estate tax-free, via the standard nil-rate band and transferrable nil-rate band, and a further £250,000, based on the current residence nil-rate and transferrable residence nil-rate bands, set to increase further in 2019-20.
There are caveats to be aware of. ‘For instance, if I was a grandparent and I wanted to leave my home to a grandchild, but they have to be 21 to inherit it,’ says Rachael, ‘that would be a Trust, with an age contingency.
‘For the purposes of this legislation, that would mean that you wouldn’t get the residence nil-rate band,’ Rachael continues. ‘There are all sorts of little nuances with the legislation, and you would need to get legal advice to clarify the best option for you.’
You can also minimise the tax bill you pass on to your children by gifting your money to them in your own lifetime. ‘If you are lucky enough to have a comfortable income, then this can be an option,’ says David Smith of Sweeney Miller. ‘There are several ways you can gift some of your money to your children or relatives, over a structured timescale.
‘Anyone can give up to £3,000 a year,’ says David, ‘as a result of something called annual exemption. This can also be carried forward one tax year, so if you hadn’t given £3,000 away last year then you can make £6,000 worth of gifts this year.
‘There are also specific instances in which you can give other amounts,’ David explains. ‘For example on occasions such as weddings, religious holidays and birthdays. You can give as many small gifts of £250 or under as you like during a given tax year, as long as you haven’t used any other exemption.’
While there are many ways to minimise the tax liability of your estate through giving, it is essential to seek professional guidance before deciding on a strategy. An expert can highlight potential pitfalls, which it is important to be aware of.
For example, you could give a whopping £325,000 away, expecting it to pass free of IHT. In fact, this will only be the case if you outlive the date of the gift by seven years or more. The scale of the gamble is mitigated by the fact that the inheritance tax payable decreases to 32 percent even if you die after three years, but it is a risk to be carefully considered.
‘It’s also a psychological thing,’ explains David. ‘You’ve built a nest and now you have to dismantle it a little bit. If you haven’t got any major life expenditures, then it’s maybe worth starting to gift a little bit to the kids.’
A Safe Pair of Hands
Self-evidently, planning your legacy in terms of your estate is no simple business. But what if this is further complicated by circumstances outside your control? While we all hope to be fully able to administrate our own affairs right up until the end of our lives, this isn’t always the way things work out. That is why it’s advisable to register Lasting Powers of Attorney and nominate a ‘safe pair of hands’, who can ensure that your affairs are arranged as you would have wished. This is particularly important as inheritance legislation is subject to change, as we have seen with the recent introduction of the Residence Nil-Rate Band. As your attorney, your nominee can ensure that your estate qualifies for all relevant tax reliefs, and that money is invested as you would have wished.
Amanda Cowie, Wealth Director at Robson Laidler emphasises the importance of considering Lasting Powers of Attorney as an option, both for yourself and for family members. ‘While acting on your behalf, an attorney would not be doing anything you wouldn’t have considered yourself.’ reassures Amanda. ‘It is important to have good conversations with any elderly relatives you have. We are all busy, but try not to put this off. Having Lasting Powers of Attorney in place is really essential for everyone’s peace of mind.’
Ask an Expert
It may come as no surprise that the Office for Tax Simplification are currently consulting on inheritance tax; nor that this article does not even scratch the surface in terms of the intricacies of kicking your estate into shape. With the future happiness – and wealth – of your descendants at stake, the case for seeking expert advice has never been stronger. Hopefully, whether you are married or unmarried, they will be able to ensure your loved ones end up richer, not poorer, and in a better position for the legacy you leave on your death.