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Understanding Inheritance Tax

Perhaps the most important aspect of effective financial planning is the anticipation of problems before they arise. One potential pitfall waiting for the unprepared is Inheritance Tax (IHT), which, if unaccounted for, has the potential to reduce the value of an estate by as much as 40%.

IHT is essentially a tax on your estate upon the time of your death (or in certain circumstances by the making significant transfers during your lifetime). This includes the entirety of your possessions and a proportion of everything that you own jointly.

In most cases this tax will need to be paid within 6 months of the date of death, to prevent interest from being charged on the amount owed.

Things that will be included against IHT include but are not limited to:

  • Property
  • Investments
  • Insurance
  • Pension plan payments and employee death benefit (unless these form part of a trust)
  • Assets held in trust from which you receive personal benefit
  • Additional assets, for example, cars, art, jewellery, furniture

What is the IHT Threshold?

At present, the IHT threshold is set at £325,000, with IHT payable at 40% on all of an individual’s estate above this level. This threshold is referred to as the ‘nil rate band’.

Given the current property market, you do not have to be overly affluent to achieve this threshold as the value of many properties can easily take you over the threshold.

Since 2007, a spouse or civil partner has been able to inherit their spouse’s unused nil-rate band. Prior to this, just as with income tax allowances, the nil-rate band of every person was treated in isolation.

In the majority of cases, the assets and property pass to the surviving spouse as an inter-spouse transfer (which is not taxable) and it is therefore possible to leave the entire nil-rate band to the spouse and double their exemption.

Who Pays Inheritance Tax?

The named personal representative, also known as executor, will pay any inheritance tax which is due on the estate.

The executor will be named within the will. Therefore, dying without a will often leads to significant complications when appointing someone to handle the affairs of the deceased.

Is it Possible to Avoid Inheritance Tax?

It is not possible to avoid inheritance tax directly but with expert careful planning it is possible to reduce the inheritance tax eventually due.

Planning For Inheritance Tax

Fortunately, there are a number of actions which can be pre-emptively addressed to help reduce any future IHT tax bills. These include:

  • Making a Will – an effective will may help to reduce IHT bills.
  • Researching Exemptions – there are a variety of exemptions which can be utilised to help reduce the value of an estate.

For example, switching assets between spouses or civil partners does not create a tax liability. If you leave 10% or more of your estate to charity, your IHT bill will also be reduced by 10%.

  • Consider Gifts – if you can afford to give away some of the assets you own, it may be possible to reduce the size of your estate.
  • Think about Life Assurance – a life assurance plan will not necessarily reduce the size of the IHT bill but the proceeds may prove to be valuable in regards to paying the bill.
  • Consider Trusts – Careful structuring of trusts can help to reduce or even eliminate inheritance tax liability completely.

Under What Circumstances Can Inheritance Tax Be Avoided?

IHT will not need to be paid if the estate in question (property, savings, investments) is either valued at below £325,000 or gifts in excess of the nil rate bands are paid to exempt beneficiaries such as your spouse or Charities.

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