Families are facing increasing scrutiny over inheritance tax, with experts warning of potential changes that could expand the tax net and increase liabilities.
Thousands more estates are expected to become liable for inheritance tax from April of next year as pensions are brought into the calculation for death duties. Currently, inheritance tax is levied at 40 percent on estates exceeding certain thresholds. A potential new estate tax, mooted by potential Prime Minister Andy Burnham, could introduce a 10 percent charge on all estates to fund social care, though it remains unclear if this would replace or supplement existing taxes.
The total cost of adult social care in England alone was £34.5 billion in the past year, an increase of 8 percent, while inheritance tax revenue for 2024-25 was £8.4 billion. If a new tax were introduced to cover social care costs, it is unlikely to reduce the overall tax burden on wealth.
Understanding Inheritance Tax Thresholds
Individuals can currently pass on up to £325,000 tax-free, known as the nil-rate band. For married couples or civil partners, this combined threshold is £650,000. An additional residence nil-rate band allows for a further £500,000 per individual (£1 million per couple) if the family home is passed to direct descendants. Experts advise assessing the total value of assets, including property, savings, and investments, to determine potential liability.
Planning for Future Liabilities
Experts recommend proactive planning to mitigate potential inheritance tax bills. Gifts made more than seven years before death are generally free of inheritance tax, offering a way to reduce an estate's value. However, individuals must ensure they retain sufficient funds for their own future needs, including potential long-term care costs. Cash-flow modeling is suggested as a tool to forecast future financial requirements and determine how much can be gifted without jeopardizing personal security.
Reviewing or creating a will is crucial to ensure assets are distributed according to one's wishes and to potentially minimize tax liabilities. For unmarried couples or those in civil partnerships, considering legal unions can provide tax benefits that might otherwise not be available.
Managing Pension and Death Benefit Nominations
The inclusion of pensions in inheritance tax calculations from next April necessitates a review of death benefit nominations. Pensions left to beneficiaries other than a spouse or civil partner may incur a tax bill. Contacting pension providers to update nominations is advised to align with current wishes and potential tax implications.
Administrative and Payment Considerations
Preparing an administrative folder with details of all assets and account access can greatly assist executors. Grieving relatives typically have six months from the date of death to pay any inheritance tax due. As executors often do not have immediate access to estate assets via probate, they may need to borrow funds or use other means to settle the bill promptly. Interest is charged on late payments.
Strategies for Reducing Estate Value
Several strategies can help reduce an estate's value for inheritance tax purposes. These include:
- Life Assurance Policies: Placing life assurance policies in trust ensures the payout is not included in the estate for inheritance tax, providing beneficiaries with funds to cover the tax bill.
- Deeds of Variation: Within two years of a death, a deed of variation can be used to redirect an inheritance to another beneficiary, potentially avoiding a second round of inheritance tax.
- Gifts and Spending: Utilizing annual gift allowances (£3,000 per person, plus unlimited small gifts up to £250) and making gifts as part of normal expenditure out of income can reduce an estate's size. Spending accumulated wealth on oneself is also a direct way to decrease the taxable estate.
- Trusts: Setting up a trust can be a way to manage assets for beneficiaries, but requires careful consideration of tax implications and potential loss of personal benefit from the transferred assets.
- Specialist Investments: Certain investments, such as shares in companies with business property relief status, may offer inheritance tax benefits after a qualifying holding period, though these are often higher-risk.
Financial advisers emphasize the importance of seeking professional guidance for complex financial planning and inheritance tax strategies, warning against misselling, particularly concerning trusts. Keeping records of gifts is also essential to avoid administrative difficulties for executors.