The world of inheritance tax (IHT) is far from straightforward. In fact, it’s filled with so many rules, figures and exemptions that it can be difficult for even the most financially savvy of people to wrap their heads around. 

Many people know that their estates can be passed to their spouse or civil partner without incurring any inheritance tax at all, but what else do we need to keep in mind when planning for the future?

To make things that little bit clearer, here are a few IHT rules you might not be aware of.

ISAs aren’t exempt from IHT

Although ISAs are tax efficient when we’re alive, they’re susceptible to IHT once we’re no longer around. Speak to us to weigh up your options and look for tax-efficient alternatives.

The nil-rate band protects £325,000 of your estate

The nil-rate band is a threshold which sees anything above the set amount being eligible for IHT. It currently stands at £325,000 and will remain fixed at this amount until April 2026. This means if you pass away with an estate worth less than this amount, your loved ones might not have to pay any IHT at all.

One exception to this is if you pass away within 7 years of making large gifts to loved ones. You’re typically allowed to give up to £3,000 away each year without the value of these gifts being added to your estate, but this changes if you die within the 7-year time frame. In this case, your nil-rate band may be reduced to factor in tax and less of your estate will be passed on tax free. 

The residence nil-rate band protects a portion of your home

In 2017, the government introduced the residence nil-rate band as an additional protection for homeowners wishing to pass the family home down to loved ones.

We’d like to add particular emphasis to the word ‘family home’ because buy-to-let properties and holiday homes are exempt. You must have been living in the property as your primary residence for it to be eligible.

It must also be passed down to direct descendants such as children or grandchildren. Foster, adopted or step-children are included but nieces, nephews and family friends are not.

Larger estates have more complicated rules

If you’re passing down a very large estate, the residence nil-rate band reduces by £1 for every £2 over £2million. This means that estates worth more than £2.35 million may not benefit from the residence nil-rate band at all. 

The good news is that we can help you find tax-efficient ways to reduce the value of your estate. For example, by giving charitable gifts, passing money to loved ones while you’re alive, and spending your cash while you can, you can make the most of it and avoid losing large sums of money to the tax man.

Whether you can pass on your retirement savings depends on the type of pension you have

Whether IHT will be payable on your pension or not will depend on a number of factors including the type of pension you have.

If you have a defined benefit pension and a fixed percentage of your final salary is paid for the remainder of your lifetime, the benefit belongs to you and can often be passed to your spouse tax-free if they outlive you. 

For defined contribution pensions, however, the rules differ. This type of pension is essentially an investment you build up during your working life.

If you use your pension to purchase an annuity that’ll pay you an income for the rest of your days, this can’t typically be left to your beneficiaries if you pass away. 

Some people may choose to go down the pension drawdown route instead of purchasing an annuity. If you choose this option, any balance remaining once you pass away will usually be given to loved ones included in your will.

Deciding what to do with your pension is by no means an easy decision, but thankfully that’s what a financial adviser is for!

Don’t hesitate to get in touch with us to discuss your concerns. We’ll look for ways to make the most of your estate while minimising the amount of IHT your loved ones have to pay.

*Levels and bases of, and relief from, taxation are subject to change.

This article was prepared by AdvisorStream and is legally licensed for use by AdvisorStream.

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