The main reason to write a will is to ensure your wishes are carried out after you die, but did you know it could help you mitigate how much Inheritance Tax (IHT) your estate will be liable for too?
Inheritance Tax
Between April and August 2023, HMRC collected £3.2bn in IHT, around £300m higher than in the same period last year, according to Money Age. This is a significant sum, especially when you consider only around 5% of estates are liable for the tax.
With a standard tax rate of 40% once certain thresholds are exceeded, IHT can have a sizeable impact on what you leave behind for loved ones. So, how can a will help you reduce the amount of IHT due?
1. Make use of the nil-rate bands
Your first step should be to make sure you’re making full use of nil-rate bands.
All estates can take advantage of the nil-rate band, currently £325,000 (Tax year 2023/2024). No IHT is due if your entire estate is under this threshold.
The residence nil-rate band, currently £175,000 can be added to the above if you’re leaving your main home to children and grandchildren. As you can leave unused allowance to your spouse or civil partner, this means you can effectively leave £1 million as a couple without your estate being liable for IHT if you make use of both allowances.
Children and grandchildren will be among the first to inherit if you don’t have a will in place. However, making it clear in a will can ensure your wishes are known as you minimise IHT.
2. Establish a trust
Assets placed in some types of trusts are considered outside of your estate for Inheritance Tax purposes.
You can create a trust during your lifetime, with this then being left to loved ones in your will. Alternatively, you can establish a trust within your will.
A trust can be used to reduce tax liabilities and can be a useful way to create provisions for children or those unable to manage their finances themselves. However, keep in mind that some assets may still be liable for IHT and you may no longer be able to benefit from the asset or the income it delivers.
Another way to use a trust is to take out a life insurance policy and place it in a trust. This won’t reduce how much IHT is due, but it can be used to cover the bill, leaving your estate intact to pass on to family. The policy must be placed in a trust, otherwise, the pay-out will count as part of your estate, increasing the amount of IHT due.
There are many different types of trusts, and some can be complex to set up with your plans in mind. Legal advice can help you understand what options suit your circumstances and ensure a trust is established properly. For instance, some trusts can continue to provide you with an income during your lifetime or be set up for children to inherit once they reach adulthood.
Make sure a trust is the right option for you before proceeding. Once in place, you may not be able to reverse the decision.
3. Leave a charitable legacy
You can make a positive impact and reduce your IHT liability by leaving a charitable legacy in your will. There are two ways charitable giving can be tax efficient.
- You can leave a sum to charity that will bring the value of your entire estate under the nil-rate band thresholds. This would mean that no IHT is due.
- If you leave 10% or more of your estate to charities, the IHT rate is reduced from 40% to 36%. For some estates, leaving this portion to charity will increase the amount that is left behind for loved ones.
This is a way of minimising IHT while supporting causes that are close to your heart.
Reducing Inheritance Tax outside of a will
The three above ways to reduce IHT aren’t your only options. You could, for instance, make use of the gifting allowance to pass on wealth to loved ones during your lifetime or provide gifts out of your income. You may also be able to pass on your pension tax-efficiently to loved ones, so it’s important to look at your estate planning in the context of your wider financial situation.
Is reviewing your will part of your financial plan?
If you don’t already have a will in place, arranging one should be a priority. Without a will, your assets may not be distributed to those you want to benefit from your estate. But even if you do have a will, you should make reviewing it regularly part of your financial plan – your assets and wishes will likely change over time, meaning adjustments may be needed.
If you’re concerned about IHT or would like to discuss what you can leave behind for loved ones, please contact the George Square team.