Continuing our series on tax allowances, today in Part III we look at inheritance tax (IHT) and how you can minimise a future tax bill with some careful financial planning. Below, we show how the residence nil rate band (RNRB) works – which is a type of “allowance” when leaving property to direct descendants – as well as your “annual exemption” for gifts. You’ll also find some other tips for crafting an IHT-conscious estate plan. We hope this is helpful to you.
The Residence Nil Rate Band
Normally, inheritance tax (IHT) is levied at 40% on the value of an estate over £325,000. This includes assets such as your home, personal possessions, and cash savings. If, for instance, your estate is valued at £500,000 when you die, then £175,000 may be liable to 40% IHT (i.e. £70,000 in tax to pay).
However, since April 2017, you can leave an additional £175,000 to your beneficiaries, free of IHT, if your estate includes a family home left to “direct descendants” (e.g. children). This is called the Residence Nil Rate Band (RNRB) and it was introduced to help those with a home which had appreciated in value since their purchase, so more people did not have to sell their property to cover their IHT liability.
Theoretically, this can allow an individual to pass down £500,000 completely free from IHT.
This may have big implications for your estate plan. For instance, those currently renting in retirement may, instead, benefit from buying a property with some of their non-pension savings (assuming this is realistic). Doing so could allow for more wealth to be passed down to children without IHT. If you are married or in a civil partnership, then your spouse/partner is also entitled to both their £325,000 IHT-free allowance and the £175,000 RNRB upon death.
Any unused IHT allowance can be transferred to the surviving person in the relationship, tax-free, allowing you to “combine” your allowances to potentially pass down £650,000 to your loved ones when you both die (or, up to £1m if you can both claim for the RNRB).
The annual exemption for gifts
Often when you make a gift, it gets counted as part of your estate for IHT purposes until seven years have elapsed (the “7 year” rule). During this time, a “taper” may apply to the normal 40% rate of IHT. For example, if you die 5-6 years after making a taxable gift, then your executors will pay 16% on its value out of your estate. So, be careful before rushing to put a house in your child’s name to try and avoid IHT!
If you do not survive the required seven years, then this could put your loved ones in a difficult financial position.
Your “annual exemption”, however, can be a great IHT-mitigation option. Each tax year, you can give away up to a total of £3,000 (either all to one person or split between many people) without this getting counted as part of your estate for IHT purposes. Your partner is also entitled to their own annual exemption, allowing you to both (collectively) give away up to £60,000 over ten years without IHT. Also, you can give up to £5,000 to a child without needing to worry about IHT (£2,500 to a grandchild or great-grandchild and £1,000 to any other person).
You do not need to wait until death for your loved ones to start benefitting from your legacy. Making annual gifts allows you to see the fruits of your generosity – e.g. watching your child use the money to put down a deposit on a house.
A note on pensions
In a previous article, we showed how each individual can put up to £40,000 into their pension(s) each tax year – or, up to 100% of their earnings (whichever is lower). However, another benefit of saving into a pension pot is that, currently, these savings can be passed down to your loved ones without IHT. This means that your pension is not just a great tool for retirement planning, but also for estate planning!
This can have important implications for how you spend money in retirement. For instance, if you have ISA savings as well as pension savings, then it might make sense to first spend the former. This is because ISAs cannot be passed down IHT-free, and you can also access the funds earlier (except in the case of a Lifetime ISA). You can save up to £1,073,100 into your pensions without the savings facing tax. Your partner can also do the same thing.
Bear in mind that you need to plan quite far ahead to maximise your pension as an IHT planning tool. Once you start accessing your pension (after age 55), you typically trigger the “Money Purchase Annual Allowance” rules which limit your pension annual allowance to just £4,000 per year. This means, for instance, that you cannot simply sell your own business in retirement and put all the proceeds into your pension.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.