Inheritance Tax Planning
If you think your estate might have to pay Inheritance Tax, here are five simple things you can do to reduce the taxman’s cut – and not all of them involve changing your will.
Make a gift to your partner
If you’re married or in a civil partnership, you can give anything you own to your spouse or civil partner – so your estate won’t have to pay Inheritance Tax on what the gift’s worth (although there are different rules if your spouse or civil partner’s permanent home is outside the UK).
Give to family members or friends
If you give something to a friend or a family member who is not your spouse or civil partner, so that you no longer get any benefit from it, the value of the gift will still be included in your estate for Inheritance Tax – but only for seven years. So, for example, if you give one of your children some money, and you live for another seven years, it won’t be counted as part of your estate when you die.
You can give away limited amounts every year and not have to pay Inheritance Tax. For example, you can give away up to £3,000 a year and you can give away money to your children and grandchildren when they get married.
Put things into a trust
If you put some of your cash, property or investments into a trust (which you, your spouse and none of your children under 18 years can benefit from), they are no longer part of your estate. So, for example, you could set up a trust to pay for your grandchildren’s education or support a family member with a disability. You can set up a trust right away or you can establish one in your will. The rules around trusts are complicated so you must take advice from an expert. Bear in mind that some types of trust might have to pay Inheritance Tax themselves.
Leave something to charity
Anything you leave to charity is free of Inheritance Tax so it can be a useful way of reducing your Inheritance Tax bill, while benefiting a good cause.
And if you leave at least 10% of your estate to charity, it will cut how much Inheritance Tax is due on the rest. The taxman will only be able to claim 36% rather than 40%. This may not be a huge saving, but it can mean that family and friends will receive more than they would do otherwise – while your favourite charities also benefit.
Take out some life insurance
If you take out a life insurance policy, it won’t reduce the amount of Inheritance Tax due on your estate. But the payout may make it easier for your surviving family to pay the bill. It could mean that they are able to prevent the family home from being sold. But if you do this, make sure the life insurance payout goes into trust – if you don’t it will make your estate bigger and it will have to pay more tax
After you die, the people tidying up your affairs have to count up the value of what you leave behind – your estate – and take off any debts and funeral expenses. Depending on how much is left, there might be Inheritance Tax to pay.
What is the Inheritance Tax threshold?
For people who are married, in a civil partnership or widowed, the threshold for Inheritance Tax is currently £650,000 between them. For single people, the Inheritance Tax threshold is currently £325,000.
Who pays Inheritance Tax?
If you’re single or the first person to die in a marriage or civil partnership
If you’re single and your estate is valued at below £325,000, then there’s no Inheritance Tax to pay. If it goes over the £325,000 limit, then Inheritance Tax has to be paid at 40% of the extra value only.
For example, if your estate is valued at £425,000, then £40,000 would be due in Inheritance Tax – because the 40% rate is only charged on the extra £100,000.
If you’re the first person to die in a marriage or civil partnership and you leave everything you own to your husband/wife or civil partner, there will be no Inheritance Tax to pay, whatever the value of your estate.
If you’re the first person to die in a marriage or civil partnership, and you do not leave everything you own to your husband/wife or civil partner, then whether there’s Inheritance Tax to pay on your estate will depend on both:
- the value of your estate, and
- who else you leave your estate to
If you’re a widow, widower or surviving civil partner
If your spouse or civil partner leaves all their estate to you, they also pass on their £325,000 Inheritance Tax allowance. You can add this to your own allowance, meaning that your own estate may only have to pay Inheritance Tax if it’s worth over £650,000. If that happens, you’ll pay 40% on the extra value only. The example below shows what might happen.
- If your husband dies and leaves you his entire estate valued at £500,000, no Inheritance Tax will be due – because spouses and civil partners don’t pay inheritance tax on money and/or property they leave to each other.
- But if you also have £300,000 of your own, then when you die, the combined estate will be worth £800,000 – £150,000 over the combined limit of (currently) £650,000.
- Inheritance Tax at 40% will be due on that £150,000, which comes to £60,000.
Find out more about how Inheritance Tax works on the HM Revenue & Customs website
If you think your estate will be over the limit
No need to worry. Even if your estate is worth more than the limit, there are things you can do to minimise Inheritance Tax. In fact, if you plan carefully, you might be able to prevent your estate from paying it at all.
If your estate will be below the limit
You don’t have to do anything – most estates don’t have to pay Inheritance Tax. So it doesn’t matter who you leave your money to, there will be no Inheritance Tax to pay.
It’s worth checking the value of your estate every so often. If you come into some property or get a cash windfall, your estate could suddenly be liable for Inheritance Tax when you’re gone. The earlier you realise this, the sooner you can set about cutting the amount due
Using a life insurance policy to pay some or all of your Inheritance Tax bill can make things easier for the people you leave behind.
It’s a good idea to set up a life insurance policy if:
- you think there will be Inheritance Tax to pay when you die but you want to make sure you can pay the bill
- you want to protect your home from being sold to pay the Inheritance Tax bill, or
- you’ve made gifts to friends and family in the last seven years – these gifts could still be counted towards the Inheritance Tax bill
How life insurance can help
You will only reduce Inheritance Tax on your estate if your life insurance policy is written in trust during your lifetime. Get professional advice.
Taking out the right life insurance policy can provide extra funds to pay Inheritance Tax on your death, and could protect important things from being taken to pay Inheritance Tax when you die.
Using life insurance to pay an Inheritance Tax bill
You can use life insurance to put money aside for the Inheritance Tax bill, making it less likely that things like your home will have to be sold. This works as follows.
- You set up a whole of life policy.
- You specify that the policy is held in trust which means the cash will be paid into the trust. Most life insurance companies can help you with this, but get advice if yours doesn’t.
- When you die, the policy pays out to the trust, which pays all or part of your Inheritance Tax bill.
If you give money away before you die
If you die within seven years of making a gift, the gift could still count towards your Inheritance Tax bill. If you’re planning to reduce your Inheritance Tax bill by giving away your property before you die, a term insurance policy can help to cover the Inheritance Tax bill if you die within the seven year period. This works as follows.
- You set up a term insurance policy.
- You specify that the policy is held in trust and that the cash will be paid into the trust, as in the previous example.
- If you die within the term of the policy, it pays out to the trust.
- This money can be used to pay some or all of the Inheritance Tax bill.
Some term insurance policies can be converted to whole of life policies when they expire.
Find the right whole of life policy for you
A whole of life policy lasts for as long as you live. It will pay out when you die, however far in the future that is. If you want this kind of insurance, you should take it out as early as you can – because as you get older the premiums will be more expensive and it can be more difficult to find a company that will accept your application, especially if you’ve had health problems.
There are several kinds of whole of life policy.
- Maximum cover – work out how much cover you think you’ll need and then find the policy that offers that cover for the lowest monthly payment. Monthly payments will change, so keep an eye out to make sure you’re still getting a good deal.
- Balanced cover – pay a bit more up front and your monthly payments are less likely to go up significantly over time. Your payout will probably be linked to the performance of the stock market, so it isn’t guaranteed.
- Guaranteed premiums – pay a fixed monthly amount over the life of the policy and get a fixed payout. It’s not easy to find this kind of policy.