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The Next Generation

May 2021

by Alex Binnington

What will your legacy look like?
The coronavirus (COVID-19) pandemic has led many people to reflect on their own mortality. No one wants to think about their hard-earned wealth going to waste after they die. Sorting out your finances early will help the people left behind when you die.

Protecting your estate is ultimately about securing more of your wealth for your loved ones and planning for what will happen after your death to make the lives of your loved ones much easier. It’s not nice to think about, but it means that your loved ones can carry out your wishes.

Lifetime accumulating wealth
If you don’t make the right financial arrangements, your family could potentially have to foot a hefty IHT bill in the event of your premature death. Passing assets efficiently to the next generation remains a primary objective for many who have spent a lifetime accumulating their wealth. Providing funds for family members or a charitable interest is also an important way to see the benefit of your wealth during your lifetime, as well as leaving a legacy.

Inheritance Tax (IHT)
IHT is the amount of tax owed on a person’s estate once they have become deceased or on certain lifetime gifts. The government assesses what a person’s estate is worth once they die, which includes any assets including property minus any debts.

Inheritance Tax is payable on everything you have of value when you die, including:

  • Any property or land (even if they are overseas)
  • Businesses you own
  • Savings and investments, including pensions, shares, cash in the bank
  • Trusts
  • Jewellery
  • Works of art
  • Proceeds from life assurance policies not written in an appropriate trust
  • Vehicles
     
    Nil-rate band (RNRB)
    The rate of tax on death is 40% (or 36% where at least 10% of the net estate is left to a registered charity), and 20% on lifetime transfers where chargeable. For 2021/22 the first £325,000 chargeable to IHT is at 0% and this is known as the ‘nil-rate band’. The nil-rate band has been frozen at £325,000 since 2009 and this will now continue up to 5 April 2026.
     
    Residence nil-rate band
    An additional nil-rate band is introduced for deaths on or after 6 April 2017 where an interest in a qualifying residence passes to direct descendants. The amount of relief has been phased in over four years and is set at £175,000 for 2020/2021. From 2021 to 2022 onwards, it will increase in line with Consumer Prices Index (CPI). Any unused nil-rate band will be able to be transferred to a surviving spouse or civil partner.
     
    For many married couples and registered civil partnerships, the relief is effectively doubled, as each individual has a main nil-rate band and each will also potentially benefit from the residence nil-rate band.
     
    The residence nil-rate band can only be used in respect of one residential property which does not have to be the main family home but must at some point have been a residence of the deceased. Restrictions apply where estates (before reliefs) are in excess of £2 million. Restrictions apply where estates (before reliefs) are in excess of £2 million (taper threshold) – the RNRB is reduced by £1 for every £2 of value by which an estate exceeds the taper threshold. Tapering can reduce the RNRB to zero.
     
    Where a person died before 6 April 2017, their estate will not qualify for the relief. A surviving spouse may be entitled to an increase in the residence nil-rate band if the spouse who died earlier has not used, or was not entitled to use their full residence nil-rate band. The calculations involved are potentially complex but the increase will often result in a doubling of the residence nil-rate band for the surviving spouse.
     
    Lifetime giving – it’s good to give
    There are ways to reduce the amount of IHT you pay. HM Revenue & Customs (HMRC) permits you to make a number of small gifts each year without creating an IHT liability. Each person has their own allowance (up to £3000 per tax year), so the amount can be doubled if each spouse or registered civil partner uses their allowance.
     
    You can also make larger gifts, but these are known as Potentially Exempt Transfers (PETs) and you could have to pay IHT on their value if you die within seven years of making them. Any other gifts made during your lifetime that do not qualify as a PET will immediately be chargeable to Inheritance Tax. These are called Chargeable Lifetime Transfers (CLTs) and an example is a gift into a discretionary trust.
     
    The taxation rules of CLTs are complicated, and you should obtain professional financial advice if you are considering a CLT. Also, if you make a gift to someone but keep an interest in it, it becomes known as a ‘Gift With Reservation’ and will remain in your estate for IHT purposes when you die.
     
    HMRC permits you to give the following as exempt transfers:
     
    1. Up to £3,000 as either one or a number of gifts each tax year (6 April to 5 April). If you don’t use it all up in one year, you can carry the remainder over to the next tax year (this can only be done for one year).
    2. Gifts of up to £250 to any number of other people during the tax year as long you have not used another exemption on the same person – but not those who received all or part of the £3,000.
    3. Any amount from income that is given on a regular basis, provided it doesn’t reduce your standard of living. These are known as gifts made as ‘normal expenditure out of income’.
    4. If your child is getting married, you can gift them £5,000; if a grandchild or more distant descendent is getting married, you can gift them £2,500; and to a friend or anyone else you know, you can gift £1,000.
    5. Donations to charity, political parties, universities and certain other bodies recognised by HMRC.
    6. Maintenance payments to spouses (and ex-spouses), elderly or infirm dependant relatives, and children under 18 or in full-time education.
    7. There are certain other gifts that can qualify for relief from IHT. These can include gifts of a small business, sole trader enterprise or partnership and shares in companies listed on the smaller, riskier stock exchange, the Alternative Investment Market (AIM).
    8. Farmers can also gain up to 100% relief from IHT when making gifts of certain agricultural land or farm buildings. But the rules in both these situations are complex and it would be best to seek expert advice before gifting anything away.
    9. Members of the armed forces, and other emergency personnel, killed in action or whose death is hastened by injuries sustained on active duty are also exempt from IHT.
     
    Life insurance policy
    If you don’t want to give away your assets while you’re still alive, another option is to take out life cover, which can pay out an amount equal to your estimated IHT liability on death. Taking out a life insurance policy written under an appropriate trust could be used towards paying any IHT liability.
     
    Under normal circumstances, the payout from a life insurance policy will form part of your legal estate, and it may therefore be subject to IHT. By writing a life insurance policy in an appropriate trust, the proceeds from the policy can be paid directly to the beneficiaries rather than to your legal estate and will therefore not be taken into account when IHT is calculated. It also means a payment to your beneficiaries may be quicker, as the money will not go through probate.
     
    Peace of mind
    Ensuring that you’ve made plans will give you peace of mind. To discuss how we could help you to pass assets efficiently to the next generation, please contact us for more information.
     
    Further information on IHT rules can be found at gov.uk.

     


    The content in this publication is for your general information and use only and is not intended to address your particular requirements. Articles should not be relied upon in their entirety and shall not be deemed to be, or constitute, advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough examination of their particular situation. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts. Levels and bases of, and reliefs from, taxation are subject to change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested. Past performance is not a reliable indicator of future results.
    Pareto Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority
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