One of the most rewarding aspects of financial security is the ability to pass on wealth to your family. Not only can this provide a much-needed financial boost, but it can also be efficient from a tax point of view.
More estates than ever are subject to Inheritance Tax (IHT), and with the nil rate band frozen at £325,000 for the foreseeable future, this is likely to increase even more. While saving tax is not the ultimate goal, a sensible plan for passing on wealth is likely to result in a lower tax bill.
There are several strategies available for passing on assets, all with their own pros and cons. You may need to strike a balance between tax-efficiency and keeping a degree of control.
In this guide, we look at the main options for passing on assets.
The simplest way to pass on assets to the next generation is to make gifts. This provides an immediate benefit to your loved ones, as well as a potential IHT saving on your estate.
You can gift up to £3,000 per tax year, in total, to anyone you choose. This is immediately outside your estate. If you don’t use all of your gifting exemption, you can carry it forward by up to one year. Gifts for special occasions, such as weddings and birthdays, are also exempt up to certain limits.
If you have a disposable income, you can also make regular gifts. These are also outside your estate, and the amount is not capped. However, they must form a regular pattern and be funded from genuine income, for example salary, dividends, or property rental. Regular withdrawals from investments do not qualify.
Any gifts that do not qualify for an exemption will remain in your estate for seven years. This is known as a Potentially Exempt Transfer (PET). If you die within this time, the gift may be subject to IHT. However, if you gift over £325,000, the tax on the excess will be reduced by 20% per year from year 3 to year 7.
One option when making a PET is to arrange an insurance policy. If set up correctly, this will provide a lump sum, allowing your beneficiaries to pay the IHT liability if you die within seven years.
Of course, one of the downsides of making gifts is that you can’t change your mind and the money is outside your control.
Set up a Trust
Another option is to set up a trust. This allows you to ringfence assets for your beneficiaries without giving up full control. It also protects the assets should any of your beneficiaries get divorced, be declared bankrupt, or prove to be financially irresponsible.
A trust is managed by trustees. These are the people responsible for investing and distributing the money, as well as paying any tax charges. The person making the gift will normally be a trustee, although it is strongly advisable to have more than one.
Trusts can either be absolute or discretionary. An absolute trust designates the trust’s assets for specific beneficiaries in fixed proportions. In terms of taxation, this works in the same way as making a direct gift.
A discretionary trust gives trustees the final say over who receives the trust’s income and capital, and when. This offers more flexibility, but can also have significant tax implications. Discretionary trusts can face entry, exit, and periodic charges if the value is over the nil rate band. Additionally, discretionary trusts pay a higher rate of income and capital gains tax than most individuals.
Some trusts allow you to keep some access to your capital. For example, a discounted gift trust can provide you with a regular income and the gift itself immediately reduces the value of your estate. A loan trust does not provide an immediate IHT saving, but allows growth to accumulate outside your estate, potentially saving on IHT in the longer term.
Trusts are a complex area and advice is recommended.
Passing on Property
In general, making a gift of property works in the same way as other gifts. However, there are a few additional considerations:
- If you gift your main residence, this is only effective for IHT purposes if you move out, or if you pay a market rate of rent.
- Similarly, if you gift a holiday home or rental property, retaining any benefit from this can make the gift ineffective.
- Gifting a property to a trust can have significant tax implications and result in administrative complexity.
- If you pass on your main residence to direct descendants when you die, up to £175,000 per individual owner is free of IHT. By gifting the property earlier, you may lose out on this benefit.
Passing on Business Assets
Special rules apply when you pass on business assets, either during your lifetime or when you die:
- Lifetime gifts of business assets may qualify for holdover relief. Normally, gifts of assets are assessed for capital gains tax whether money changes hands or not. Where holdover relief applies, no CGT applies at the time of the gift. The recipient’s eventual CGT liability will be based on the donor’s original cost rather than the value at the time of the gift.
- Most trading businesses qualify for Business Relief. This offers a 100% exemption from IHT on private company shares and certain assets owned by the business. Your estate may also be eligible for 50% relief on any property that is owned personally and used by the business.
Write a Will
Whether you plan to make gifts during your lifetime or not, it is important to make sure you have a will and that it is up to date. The intestacy rules may not distribute your estate in the way you require, particularly if you have an unmarried partner, friends, or step-children to take into account.
There are some options that you can include in your will to help with IHT planning. For example, if you gift 10% of your net estate to charity, you receive a 10% reduction in IHT on your residual estate. You can also set up trusts within your will, which can help to reduce IHT for the beneficiaries, or on second death in the case of a couple.
It’s a good idea to start planning early to ensure that you maximise the tax benefits and that more of your estate goes to those you intended.
The content in this article was correct on 15/11/2022.
You should not rely on this article to make important financial decisions. Teachers Financial Planning offers independent financial advice on savings, pensions, investments, protection and mortgages for teachers and non-teachers.
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