Many people wait until their 70s before trying to mitigate inheritance tax and miss valuable opportunities earlier in life, say experts.
Larger gifts are subject to the well-known rule that you have to survive seven years before they become tax free, and if you are wealthy enough to set up a trust you can pass on far more by doing this in your 50s or 60s.
People aged in their 70s or 80s have often put off thinking about it or were reluctant to give money away to their children when they were younger, but by then there is not much time left, explains Osbornes Law.
Inheritance tax: Around 5 per cent of people leave estates sufficiently large to make their beneficiaries liable for inheritance tax
You need to be worth £325,000 if you are single, or £650,000 jointly if you are married or in a civil partnership, for your loved ones to have to stump up death duties.
But there is a further chunky allowance – known as the residence nil rate band – which increases the threshold to a joint £1million if you have a partner, own a property, and intend to leave money to your direct descendants.
If you are worth more than this, your heirs will have to hand over 40 per cent of your assets above those levels to the Government.
We look at the pitfalls to avoid, and how to mitigate inheritance tax when you are younger and already older below.
‘We are often approached by clients in their 70s and 80s who want to leave large sums to their family and are worried about how much of their estate is going to end up in the hands of the Treasury,’ says Jenny Walsh, a partner specialising in wills and trusts at Osbornes.
‘Given the average person in the UK will live until they are 81 and there are strict rules around how much cash can be given as gifts and how much can be put into a trust without incurring charges, they have not left themselves the time needed to make a real difference.
‘Another reason to start young is to avoid potential scrutiny from the authorities who will investigate if they believe someone has deliberately deprived themselves of assets to avoid payment of care fees.
10 ways to avoid inheritance tax legally
Find out how to stop the taxman grabbing some of your estate from your loved ones here.
‘Those leaving it until they are in their 80s to give money away or put it in trust are likely to find it harder to show the local authority that these gifts were not made with the intention of depriving their estate of funds to pay for their care.’
Ian Dyall, technical manager at Tilney Financial Planning, says: ‘The UK inheritance tax legislation is deliberately drafted to limit people’s ability to mitigate inheritance tax during the last few years of their life.
‘Whilst there are some things that can be done later in life, giving money away to reduce the liability, whether that is a gift to a trust or a gift to an individual, generally takes seven years before it is effective.
‘If you wish to gift using trusts, perhaps to protect the money and maintain a level of control, you are further limited by the fact that each donor can only gift up to the nil rate band of £325,000 in any seven-year period.
‘Any excess will be liable to a lifetime inheritance tax liability at 20 per cent. Planning early is therefore essential, but the challenge is how do you ensure that you are not giving away money you may need.’
James Ward, partner and head of private client at law firm Kingsley Napley, says: ‘When you are in your 60s, seven years can whizz by without a second thought but when you are in your late-70s and 80s, seven years can feel like an eternity.
‘For inheritance tax planning, seven years is the magic number of years you must survive if you want to gift assets to your children and not pay inheritance tax.
‘So rather than taking a chance with being able to survive seven years, it is sensible to gift when you are in your 60s and early 70s.’
What inheritance tax planning might you prioritise while younger?
Gifts: You can give gifts of up to £3,000 each tax year without any inheritance tax becoming payable, says Jenny Walsh of Osbornes.
How many estates are stung by the ‘death tax’?
Inheritance tax was originally designed as a levy on the very wealthy, but triple digit property inflation since the 1980s has dragged more ordinary families living in expensive areas into its net.
Around 5 per cent of people leave estates sufficiently large to make their beneficiaries liable for inheritance tax.
However, the property boom of recent decades means that figure is expected to rise, with those inheriting in house price hotspots bearing the biggest financial burden.
‘There are also other exemptions such as certain gifts given on marriage and small gifts of £250 per person per tax year. Larger sums will be subject to inheritance tax if you die within seven years.’
Trusts: This is an option if you are looking to reduce your inheritance bill and don’t want to give cash away to family yet, says Walsh.
‘Every seven years you can put £325,000 into a trust without incurring a charge to inheritance tax.
‘If more than £325,000 is transferred to a trust then there is an entry charge of 20 per cent, tax charges at a maximum of 6 per cent every 10 years and when assets are transferred out of the trust.
‘Provided you live for a further seven years from the date of transferring the funds to a trust, this money will fall outside of your estate for inheritance tax purposes.’
Walsh says the ideal age to begin this process is in your 50s, because for most people this gives them enough seven-year periods to move a significant amount into a trust.
‘It is important to be aware of possible capital gains tax if transferring an asset other than cash – such as a property or shares – into a trust, as the transfer is a disposal,’ she adds.
‘Hold over relief may be available on such assets, though this is deferring the charge to capital gains tax rather than avoiding it.’
What can you still do when already older?
Business relief: ‘If the seven years survivorship does not look achievable or you cannot afford to gift early or you do not trust your children, then you can take advantage of the business relief exemption,’ says James Ward of Kingsley Napley.
‘This sees certain investments in smaller companies, which are owned for at least two years, qualifying for full inheritance tax relief.
‘There are some risks attached to investing in such a way and financial advice must be sought but the opportunity of saving 40 per cent inheritance tax is one that many of my clients take if they only start their tax planning in their 80s.’
What if you want to mitigate inheritance tax but might want the money?
Defined contribution and final salary pensions
Defined contribution pensions take contributions from both employer and employee and invest them to provide a pot of money at retirement.
They can be tapped from age 55, although when you take out anything beyond the 25 per cent tax free lump sum there is a limit on how much you can save further and still benefit from tax relief.
Unless you work in the public sector, these pensions have now mostly replaced more generous gold-plated defined benefit – or final salary – pensions, which provide a guaranteed income after retirement until you die.
Pensions: Defined contribution or ‘money purchase’ pensions are an option where access to funds can be maintained despite being outside of your estate for inheritance tax, says Dyall.
‘Any money purchase pensions can be passed to nominated beneficiaries on death without inheritance tax.
‘If you die after 75 the beneficiary will pay income tax on the money as they draw it, but if you die before 75 then there is no income tax to pay either.
‘This means that building pensions then preserving them in retirement by living off other assets can be a very effective way of mitigating your liability without compromising your financial security.’
Inheritance: ‘If you receive an inheritance from someone it is possible to divert that to a trust within two years of their death using a deed of variation,’ says Dyall.
‘This immediately removes the inheritance from your estate for inheritance tax purposes, but you can be a beneficiary of that trust which means that you still have potential access to the money.’
Lifetime trusts: ‘There are also lifetime trusts available which, after seven years the money held in the trust is outside of your estate, but they continue to provide access to regular maturing policies should you require them, or they can be deferred if you don’t,’ says Dyall.
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