When people speak about tax planning, they are usually referring to arranging their affairs to plan for the possible payment of inheritance tax, although other taxes should also be taken into consideration at the same time.
Since inheritance tax is a tax which is usually payable when somebody dies and the making of a Will is the best way of planning what will happen when you die, the two subjects go together well.
This guide concentrates on inheritance tax, how it is charged and ways in which it can be avoided, both during your lifetime and after your death, using a Will.
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Inheritance Tax – the basics
When a single person dies, the net value of their estate (everything they own less everything they owe) is calculated and if it is valued at more than £325,000 (the nil rate band threshold), the surplus is taxed at 40%.
The value of any large gifts that they have made over the previous 7 years is also taken into account when calculating the value of their estate. It is also possible that the value of any gifts made in the 7 years prior to that could also be counted, so executors do have to look back, potentially over a 14 year period.
Where a surviving spouse or civil partner dies after 9th October 2007 and the first spouse or civil partner did not make use of their nil rate band threshold, it is possible for the survivor’s available threshold to be increased to a maximum of £650,000.
From April 2017, an extra allowance has been introduced where you are leaving a property that you have lived in, to direct descendants. This will be an extra £175,000 per person.
The tax is generally payable out of the deceased’s estate before the beneficiaries of the estate receive their inheritance.
Not all gifts have their values added back into the estate; certain gifts are exempt.
Each individual is allowed to give away certain amounts every year completely free of tax. These include £3,000 as a personal allowance, plus any number of gifts of £250 to different people, plus wedding gifts of £1,000, £2,500 or £5,000 depending on how you are related to the person getting married.
All gifts, of whatever value (on death or during your lifetime) to spouses, civil partners or charities are free of tax.
All gifts out of surplus income are also exempt. Making use of this is a very good way of reducing the eventual inheritance tax bill but your executors will have to show that the income was surplus to your requirements after all expenditure has been paid.
Gifts can be made to individuals or to trusts but they must be truly given away. If you try to reserve any present or future benefit in what you are giving away, the Revenue will treat you as not having given it away at all.
Making a Will
There are many reasons to make a Will, not just tax planning reasons.
In a Will, you decide who will sort out the administration of your estate (your executors) and who receives what you have to leave (your beneficiaries). If you do not make a Will, the intestacy rules will decide this for you.
Wills are also used to appoint guardians for children, set up trusts to control the way in which certain assets are used, protect property from being used to pay care fees and to set out your funeral wishes.
We have produced a separate guide giving more information about Will-making.
How can I use a Will to save tax?
As has been seen above, any gifts to charity or to surviving spouses or civil partners are free of tax. Also, every individual has their own nil rate band threshold. In addition, certain assets (business and farming assets for example) attract reliefs from tax.
It does not make sense for assets or amounts that would not produce a tax bill to be given to beneficiaries who are tax-exempt beneficiaries. For example, if business assets are given to a surviving spouse, two tax reliefs apply and so one is wasted.
It would be better for assets that attract tax relief to be given to beneficiaries who do not. The correct wording in a Will can arrange this. However, you may want your spouse to inherit your business for example and so advice needs to be taken as to how you can arrange this whilst still making best use of all the tax reliefs available.
What are Nil Rate Band Discretionary Trusts?
Prior to October 2007, it was common for spouses to leave an amount up to their nil rate band threshold to a trust. This was on the basis that it was wasting the nil rate band because of the spouse exemption.
The reason a trust was used was that if this amount was left to an individual, it might well leave the surviving spouse short of money. A trust could be used to keep the money out of the surviving spouse’s estate whilst providing for him or her if needed.
What about after October 2007?
It could be said that, since the surviving spouse or civil partner can now use their deceased partner’s nil rate band, leaving it to them on the first death would not be a waste. If the sole purpose of leaving it elsewhere was just to save tax on that amount, then that would be correct and it would be better to now have simpler Wills where everything is left to each other on the first death.
However, there are a number of reasons, apart from tax saving, why trusts should be used.
- It can be useful to have the flexibility of a separate pot of money to provide for unforeseen circumstances
- Money in a discretionary trust is protected if the surviving spouse or civil partner goes into care
- You may not want your surviving spouse or civil partner to have all of your estate
- You may want someone to control that money, where you have divorcing, wayward or mentally incapable beneficiaries
In addition, trusts like these can still save inheritance tax. At the moment, it is highly likely that the growth over time in the value of the amount in the trust will be greater than the increase in the value of the nil rate band threshold. That growth would be outside the survivor’s estate and so would not be taxable on his or her death.
It is vitally important to use all the ways available to you to save the payment of inheritance tax when you die. Although you will not have to pay the tax yourself, your beneficiaries will and it will make the administration of your estate more complicated for everyone involved.
The potential “doubling” of the nil rate band, introduced in October 2007, changes things slightly for married couples or civil partners with uncomplicated estates, which are worth between approximately £300,000 and £500,000, but there are still plenty of circumstances where the traditional Nil Rate Band Discretionary Trust Will is an important way of organising your affairs.
The introduction of the ‘Residence Nil Rate Band’, from April 2017, gives further scope for tax planning through wills.
At Onions & Davies, we know that every individual’s circumstances are different and that is why we take care to listen carefully to what you want to achieve and advise you fully on all the options available to you.
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This information refers to the law of England & Wales only, which from time to time changes. In particular, tax information changes annually. It is not a substitute for professional advice, which is up to date and specific to your needs. This information is a summary of the provisions relating to tax planning through wills and cannot cover every aspect of their operation. It represents our understanding of current legislation in England and Wales but should not be relied upon as an authoritative statement of law nor as constituting advice. We would advise that legal advice be sought in every circumstance.