How does Inheritance Tax work?
When you die, the value of your estate has to be established. This includes everything that you own at the date of your death and can include your home. If you leave your entire estate to your Husband, Wife or Civil Partner, then you won't have to pay inheritance tax. However, if you leave your assets to other beneficiaries then tax can be payable depending on the size of your estate.
Individuals have a "nil rate band" of £325,000 and, if you leave your home to your "direct descendants" (which includes adopted children, foster children, stepchildren, or grandchildren) then your estate may also qualify for the "residence nil rate band" which is currently £175,000. This can give an individual's estate a tax free threshold of £500,000.
In addition to this, the "unused" thresholds can be transferred between spouses and civil partners. This means that it is possible to have a tax free threshold of £1 million on the death of the second spouse or civil partner. Anything above that would generally be taxed at 40%.
What about the family home?
For many people, the family home is their main asset. Tax planning around the family home can be problematic but there are some options. If you decide to give your home away, then you would have to move out and survive for a further seven years for the gift to be removed from your estate for inheritance tax purposes.
If you want to give your home away but continue living there, then this will generally be viewed as a "gift with reservation" (where you give something away but continue to benefit from it) and it would still have to be included in your estate. In order to remove the value of the property from your estate you would have to pay rent to the new owner at the going rate, pay your share of the bills and survive for seven years.
Another option may be to consider a lifetime mortgage, as this can reduce the value of your estate. It has been reported in the news recently that the number of over 60s taking out mortgages has skyrocketed, and this is to "avoid inheritance tax". The value of mortgages that are being taken out by people aged 61 and over has increased by 24% from 2021 to 2022. When you die, the mortgage is still outstanding and is therefore deducted from the value of your estate. This can reduce the amount of inheritance tax that has to be paid.
However, it would be necessary to consider this option very carefully and, as with any tax planning, to take specialist advice.
We spoke to Harry Ward, of SG Wealth Management, to gain an insight into inheritance tax from the perspective of a Wealth Manager. Harry explained the risks of Lifetime Mortgages.
'Inheritance Tax is a widely disliked tax system where people feel they are being taxed on money they have already paid taxes on, such as income, dividends, and capital gains. Luckily, it is possible to reduce your potential inheritance tax liability through proper planning and advice.
Using a mortgage for inheritance tax planning can be beneficial, but there are drawbacks to consider:
1.If you already own your home without a mortgage and you take out a mortgage with the view of decreasing your inheritance tax, you need to decide what to do with the money borrowed against your home's equity.
2.Having a mortgage payment increases your regular expenses, which limits your ability to use the "normal expenditure out of income exemption".
3.You are affected by the changes in interest rates, which have recently risen significantly.
From a financial planning perspective, there are several options available to mitigate your tax liability. These include getting a whole-of-life insurance policy to cover the potential tax or making lifetime gifts to reduce the value of your estate. However, it is crucial to seek proper tax planning advice as there may be better solutions based on your specific circumstances and requirements to claim exemptions or reliefs.
As Chartered Financial Planners, we would engage in detailed discussions with you to understand your current and future circumstances, needs, and goals. This helps us create cashflow forecasts that illustrate your future financial position, based on certain assumptions. These forecasts enable us to explore various options available to you. For instance, they may show that you can afford to make substantial one-time gifts to your children now, such as contributing to their house deposits, which you may have considered but were unsure about affordability.
As demonstrated by the above, Inheritance Tax planning is complex, so if this is something you are considering, please do not hesitate to contact us to arrange an initial discussion.'
At Clapham & Collinge we have a dedicated Private Client Department who can assist with various aspects of later life planning. To get in touch with our specialist team, contact our Client Relations assistants on 01603 693510, or email enquiries@clapham-collinge.co.uk.
For financial advice regarding inheritance tax, get in touch with Harry Ward from SG Wealth Management, by calling 01603 760866, or email hello@sgwealthmanagement.co.uk.
