Four Inheritance Tax traps to avoid

Inheritance Tax (IHT) is one of the most feared and least understood taxes. The good news is there are lots of steps you can take to reduce the amount of tax paid by you and your family.   

What is Inheritance Tax?

In its most simple form, it’s a tax on what you leave behind when you die. The first £325,000 is normally tax free, as is up to £175,000 of the value of your home, provided it is left to a ‘direct descendant’ which includes your children and grandchildren. Anything over and above these amounts is taxed at 40%.  

While anything you leave to your spouse or civil partner is normally tax free and they can claim your unused tax-free allowances, families can still be left with some eye watering bills. Here are four common traps to avoid:

1. Why your pension should be the last thing you spend

While it may sound counter intuitive, for those that can afford to, it makes sense for your pension to be the last thing you spend in retirement, as it can bring Inheritance Tax benefits. The reason is that in most cases anything left in your pension funds on death is normally free from Inheritance Tax. Most other investments, including ISAs and Bank and Building society accounts, are caught in the Inheritance Tax net.     

2. Is your life insurance policy in trust?

One of the main reasons for taking out life insurance is to benefit our loved ones after we’ve died. Many people are unaware that unless they put their life insurance in trust it will be included in the value of their estate and their family could lose up to 40% of the proceeds in Inheritance Tax.

The good news is that putting your life insurance policy in trust will not only keep it free of Inheritance Tax in most cases, it will also speed up payment in the event of a claim, as your family won’t need to wait for probate.

If you have a life insurance policy that isn’t in trust you should contact your provider.              

3. Receiving an inheritance that makes your tax problem worse

If you already have an Inheritance Tax problem, receiving a legacy from a late loved one may only make your situation worse. If you gift the money or assets received to your own family, you normally need to live seven years, otherwise the value will still be included in your estate.

There is an alternative. Within two years of the death of the person who left you the legacy, you can do a ‘deed of variation’ which allows you to divert the inheritance to others, including family members or into a trust for their benefit. This will ensure that the legacy is not included as part of your estate.    

4. Missing out on Inheritance Tax exemptions

One of the most effective ways to reduce paying Inheritance Tax is to make lifetime gifts. For some gifts you need to live seven years after making them, however, there are other gifts you can make that are immediately exempt from Inheritance Tax, even if you die shortly after making them.

How much can you gift tax free?

There are several exempt gifts these include:

  • Gifts from your excess income – If you make regular gifts from your income that do not impact on your normal standard of living, these can be immediately exempt from Inheritance Tax. The amount you can give away will depend on the level of your income and regular expenditure. It’s important to keep records of both and your gifts, as this exemption is claimed after your death. 
  • Annual gifting allowance – You can give away up to a total of £3,000 each tax year completely exempt from Inheritance Tax. If you didn’t use your allowance in the previous tax year, you can go back one year and get it, allowing you to give away £6,000.
  • Gifts on marriage – you can give your child up to £5,000 on their wedding day, a grandchild up to £2,500 and anyone else up to £1,000 exempt from Inheritance Tax.
  • Gifts to charity – Any gifts you give to a registered charity during your lifetime are immediately exempt from Inheritance Tax.

The main Inheritance Tax threshold of £325,000 hasn’t changed since 2009, which has meant more families now face a potential Inheritance Tax bill.

What next?

If you would like to find out more about Inheritance Tax, including help with estate planning, you can give us a call on:

0800 622 323

You can also find out more about the services we offer through our financial advice service.

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Inheritance Tax advice is not regulated by the Financial Conduct Authority or the Prudential Regulation Authority.

Financial advice is provided by NFU Mutual Select Investments Limited.