Fantastic IHT mistakes and how to avoid them

Don’t get caught out with these common Inheritance Tax planning mistakes.

Inheritance Tax (IHT) can be a minefield of unintentional errors that are completely natural to make but have some pretty dire consequences further down the line, especially for your beneficiaries when it comes time to pay the IHT bill.

Get ahead of any potential problems with efficient IHT planning. This means planning far in advance to ensure your heirs won’t have any nasty surprises when it comes time to deal with your estate.

In this article, we’ll delve into the most common issues we see happen again and again to trip up even the most diligent client.

Properly understanding the seven-year rule

When it comes to gifting money or assets to others, the seven-year rule is well known to anyone looking into IHT.

The rule is essentially that once you make a gift, if you live seven years beyond that point, there is no IHT to pay on it, since it is no longer considered to be part of your estate. However, if you do die within those seven years, then there is some IHT liability and a percentage will have to be paid in tax.

What most people don’t realise is that there is a taper of the amount payable in IHT depending on how many years it’s been since the gift was given. But this taper is only applied AFTER the Nil-Rate Band (NRB) threshold of £325,000 has been reached.

When a person dies, their “failed gifts” are the first thing reabsorbed into the value of the estate. In fact, the gifts are the first thing used toward the NRB threshold. It is only after gifts are all added back into the value of the estate that the taper comes into effect, and then only if that gift exceeds the £325,000 threshold.

For instance, if you gave a gift of £750,000 and died within seven years of giving it, only the first £325,000 is free from IHT. The rest is liable for IHT as follows:

Failing to consider the £2m limit

Through the Residence Nil-Rate Band (RNRB) you gain a further £175,000 per person to pass on to your direct descendants by leaving them your main home, or share thereof. Your home also needs to be of suitable value. Couples can take further advantage of this by combining their RNRB, giving them a total additional allowance of £350,000 IHT free when gifting their main residence; there are, however, some caveats.

If an individual’s estate is worth more than £2M, then a taper comes into effect, which means you are liable for more IHT. The RNRB tapers by £1 for every £2 of the estate’s value above the £2M threshold.

Many are not aware of this £2M threshold and believe that they will be able to take advantage of RNRB without knowledge of this additional tapering that comes into play over £2M.

The best way to deal with this is to reduce the overall value of the estate to below £2M. This can be achieved through gifting but as we’ve explained above, this also comes with some caveats.

A further significant consideration is structuring a couple’s estate so that the allowances are considered on each death. This also requires appropriate Wills, ideally with appropriate Trusts. Standard Wills, with no Trusts and leaving everything to a surviving spouse/ civil partner could lead to the RNRB allowances being lost/ tapered. The RNRB could also be lost when considering non married couples.

Gifting a home is a fantastic thing to do for those in the position to do so, but being aware of how the thresholds work and when you will be able to gain the full RNRB allowance is all important.

Not being aware of the downsizer addition

Selling a property does not necessarily mean you will miss out on the RNRB either. You will still be able to have an RNRB allowance if you qualify for a “downsizer addition”.

The criteria for being able to claim this are:

• You sold, gave away, or downsized to a less valuable property after 8^th July 2015
• If the home had been kept until death (instead of being sold) it would have qualified for the RNRB
• A portion of the estate is inherited by direct descendants

With this in mind, claiming a downsizer allowance will net you a substantial saving on your IHT bill should you meet any of the criteria.

To take advantage of this you need to make a downsizing addition claim within a two-year window after the person has died.

Not having a will!

This one is sort of a no-brainer, but it is worth discussing, nonetheless. If a person dies without a will in place, it can be extremely costly to the estate.

This is because there are no instructions on what to do with the estate upon death, so the decisions will be made by the courts, leaving wishes open to interpretation and relatives having no control over who gets what and where the money goes.

Add to this the fact that there is also no way to make sure the estate is handled in the most tax efficient way and it quickly becomes obvious why having a will is such an important part of estate planning!

Unmarried couples may be open to more IHT liability

Living as joint tenants or tenants in common has implications for your IHT. It’s unfortunate, but being an unmarried couple means having a less generous IHT allowance when compared to married couples.

If an unmarried couple are joint tenants of a home they own, they own the property jointly. This means that if one of them dies, the entire property falls to the remaining person; however, the deceased’s share in the property is subject to IHT (if the estate exceeds the NRB). When the surviving owner dies, the estate is again subject to an IHT charge.

In order to be IHT efficient, we would recommend severing the tenancy on the property. This gives each partner their own share of the residence, which is valued at a lesser amount than their share as joint owners, and prevents the surviving partner automatically inheriting the entire value of the house on first death. In doing this, each partner’s individual IHT liability is reduced, and they are free to gift their share of the property to children, or place it into trust for their surviving partner, with less IHT risk.

Ignoring the Nil-Rate Band

Many fail to utilise the NRB or RNRB IHT additions to full effect, or worse, are completely unaware of them altogether.

Simply being aware of all the threshold limits and when and where they kick in and under what circumstances can help you immensely in your estate planning journey.

Understanding thresholds allows you to structure your estate in such a way that you can maximise how the allowances are applied, giving you the power to navigate IHT with much more confidence.

Not taking advantage of smaller gifting

We’ve covered the seven-year rule, which usually applies to gifts of a substantial value, enough to affect your IHT bill directly, but with adequate planning, there are also gifting rules anyone can take advantage of that, over the long-term, could help to ease the IHT burden of your estate.

IHT exempt gifting includes:

• Unlimited gifts of up to £250 to multiple people
• Gifting from surplus income, as long as it doesn’t negatively affect your standard of living
• Wedding gifts for children of up to £5,000
• Annual gift allowance of £3,000 per year

By using these exemptions strategically, you can slowly minimise your estate’s tax liability over the years. Planning early can even allow you to avoid the seven-year rule altogether if you plan effectively.

Not using trusts effectively

It’s common for people to avoid trusts altogether, believing them to be an unnecessary additional complication for their estate. However, it can’t be overstated how useful they are as a tool to manage funds and help avoid surprise IHT bills.

Assets placed in trusts can even be potentially removed from your estate for IHT purposes, ensuring that they aren’t taxed multiple times or are mismanaged upon your death.

The most useful types of trust include:

• Bare Trust – often used to hold assets for a child until they reach 18, the Bare Trust involves Trustees being appointed to keep assets protected for the beneficiary until they come of age.
• Discretionary Trust – the trustees have the power to decide who benefits from the trust. They decide how much a beneficiary receives and when.
• Interest in Possession Trust – beneficiaries are entitled to income from the trust but only for a specific period of time (sometimes for life), and after the time has elapsed the assets pass on to another beneficiary.

The best thing to do if you consider managing your estate through a trust is to consult professional advice.

Seek professional advice

One of the biggest mistakes a person can make when planning for the future of their estate is to not consult the experts.

It’s easy to make costly mistakes and miss opportunities to create a multi-generational legacy by going it alone. There are many ways to reduce the taxable value of your estate and avoid obvious pitfalls that trip up even the savviest person.

Get in contact today to book a consultation with one of CTT’s experts, we’ll review your estate and the myriad ways we can help you mitigate your IHT burden.