Having recently moved house and also reviewed my end-of-year portfolio and finances, this is probably a good time to expand on some brief notes I made on inheritance tax.
Whilst many pensions are usually exempt from inheritance tax, the total value of any house, cash or investment ISA will form part of your estate and is therefore liable to 40% inheritance tax (IHT) on death. For most people, it's not an issue as their estate is valued well below the threshold. However, as the value of property such as your main residence or buy-to-let properties and also (hopefully) investments rise over the years, it will pay to be aware of the potential liability for inheritance tax as the value of such assets rises over £300,000.
Currently only around 1 in 20 people become liable for inheritance tax but given the rise in property prices, particularly in London and the South East, it is very likely that more people will become liable to the 40% tax in future.
IHT, otherwise known as the Death Tax, only kicks in when you die.
There is nothing to pay if your estate - i.e. the value of everything you own - is:
1. Less than £325,000
2. You leave everything over this figure to your spouse/civil partner or a charity.
If neither of the above applies then your family will pay 40% IHT on the value of the estate above £325,000. So, if the estate is valued at £500,000, your estate pays the taxman £70,000 (£500,00 - £325,000 is £175,000 x 40%). Any tax due must be paid 6 months after the date of death.
Main Residence Allowance
If you own your main residence and you are leaving this to children or grandchildren, then you will get an additional 'main residence' allowance of £175,000 (currently) added to the £325K which means that up to £500,000 would be tax-free for estates worth less than £2 million.
So, in the above example, if the estate was left to children/grandchildren and included a main residence then instead of a £70,000 tax liability, no IHT would be due.
A married couple including civil partners can currently leave up to £1 million tax-free as the surviving spouse can use the deceased partner's allowance - £500K if there's a house involved which is common.
You can make a gift of up to £3,000 each year to anyone free of tax. In addition, you can make a wedding gift of up to £5,000 to children and £2,500 to grandchildren and £1,000 to others tax-free.
Beyond this, you can give any amounts to family or anyone else but such gifts are regarded as potentially exempt transfers under the seven year rule.
The 7 Year Rule on Gifts
Money or other valuable assets given away before death will still be counted as part of your estate but are regarded as potentially exempt transfers. If you survive for 7 years or more after the transfer then it becomes exempt from IHT. There is a sliding scale of tax due for gifts made less than 7 years before death. Within the first 3 years it will be 40% and then reduces by 8% each subsequent year.
In the past, pensions were taxed at 55% on death however this changed in 2015. Now, much will depend on the type of pension and also the age when you die.
With SIPPs and income drawdown plans, the 55% death tax has gone and now the beneficiaries will pay no tax if the pension holder dies before age 75 and after that age, they pay tax at their notional rate...usually 20%.
However these new rules do not apply to final salary schemes - also known as defined benefit - which provides a guaranteed income for life and then a reduced pension for a spouse or civil partner.
Shares Listed on AIM
The value of most (but not all) shares listed on the Alternative Investment Market or AIM will be exempt if held for at least two years prior to death. This is because the assets qualify under the provisions of Business Property Relief (BPR). For example, I currently hold shares in ITM Power and Ceres Power which are both listed on AIM so their value would not count as part of my estate provided I had held for at least two years.
Under the same BPR provisions business owners may well qualify for exemption from IHT on the value of their business, including shares in their business if a limited company, provided they were the owner of the business for at least two years prior to death.
Life Insurance and Trusts
Finally, it is possible to reduce or mitigate liablity for IHT by setting up a trust or taking out life insurance.
The basic idea is that some of your assets are given to the trustees via a trust deed for the benefit of others (beneficiaries) such as family members. The property is then held in trust and does not form part of your estate on death. It can be expensive to set up and administer a trust over many years and also, once the assets are transferred to the trustees, it usually cannot be reversed.
Likewise, if a life insurance policy is written in trust, the payment made on death will not become part of your estate but can be paid out directly to your spouse or other beneficiaries.
In the above cases it is advisable to seek specialist help from an IFA, tax advisor, insurance specialist or solicitor.
Some people who have been lucky to accumulate assets in excess of half a million pounds during their lifetime may well not have a problem seeing some of it pass to the taxman after they have gone. After all, our governments are under increasing pressure to pay for our NHS that has served us so well as a nation during the Covid pandemic as well as repaying all the debts - estimated additional £350 billion -that have been accruing over the past year due to paying the nation to stay at home.
Others believe that having worked hard and paid a lot in taxes and national insurance over many, many years, they draw the line at paying a further 40% when they pass away.
I can actually see both points but for the time being it's academic and I do not have to make a choice...but will be keeping an eye on property prices and my investments.
If you have any views in IHT or have taken steps to mitigate future liability, feel free to leave a comment below.