UK estate planning explained: 3 key areas to know about as you head into later life

“Estate planning” describes laying out a strategy for how and when you’ll pass your wealth to the next generation. Find out 3 key areas to consider here.

There is no doubt that you’ll have spent some time considering how you’d like to provide for your spouse, children, and wider family after you’re gone.

Although it may be decades before you pass away, it’s crucial to begin deciding how much you’d like to pass down, and to who, much earlier in life. These choices are known as your “estate plans”.

If you’re approaching retirement age and want to look at your estate plans a little more closely, keep reading to find out three important areas that everyone should know about.

1. Inheritance Tax: what is it, and who will pay?

Inheritance Tax (IHT) exists to prevent very large estates from being passed to individuals (other than a person’s spouse) tax-free. Not all families pay IHT – it depends on how much you pass down. IHT is usually charged at a rate of 40%.

Importantly, there are “nil-rate bands” under which no IHT is due. These are the:

· Nil-rate band, which applies to all estates

· Residence nil-rate band, an additional relief granted to those inheriting a home from parents, grandparents, or great-grandparents.

As of 2023/24, and until 2028, the nil-rate bands are as follows:

Tax year

Nil-rate band

Residence nil-rate band

Total for individuals

Total for married couples or civil partners

2023/24

£325,000

£175,000

£500,000

£1 million

 Source: HMRC

So, if you are passing down a family home in addition to other assets, your children could inherit a total of up to £500,000 tax-free, or up to £1 million if you and your spouse combine your nil-rate bands.

The rules around which properties can count as a “home”, and passing down properties in general, are complex. You can read our full insights on IHT and property on our news page.

In general, though, if you’ve accumulated a substantial amount of wealth that consists of property, shares, business assets and personal wealth, your family may pay IHT when you pass away.

It’s not all bad news – remember, you and your spouse could potentially give an inheritance of up to £1 million tax-free – but you may worry about how much of your estate could be taken by HMRC upon your death.

This is especially notable in the 2023/24 tax year because the nil-rate band was frozen at £325,000 in 2009, and the residence nil-rate band has been fixed at £175,000 since 2020. As a result of these freezes, HMRC’s IHT receipts are rising.

Indeed, MoneyAge reports that in the first two months of the 2023/24 tax year alone, HMRC took £1.2 billion in IHT – up 13% from the previous year.

So, understanding how much tax your estate might incur now can help put mitigating steps in place over the coming years, perhaps enabling your family to inherit more in future.

Working with a financial planner can be hugely helpful here; we understand how IHT works and can help you prepare for it over the years.

1. Giving financial gifts before your death

To avoid your loved ones paying a large IHT bill when you pass away, and to offer them life-changing opportunities in the present, you might consider giving away some of your wealth now.

Offering financial gifts, in the form of cash, shares or property, can be constructive in mitigating IHT – but there are a few catches to this strategy.

Potentially exempt transfers

If you give away any number of assets and pass away more than seven years after transferring them to a child or other family member, no IHT will be due on those assets, as they are no longer considered to be part of your estate.

However, if you die before seven years is up, these assets may still form part of your estate for IHT purposes. This means that more of your assets could be pushed above the nil-rate bands and be subject to IHT.

That’s why large gifts are known as “potentially exempt transfers” (PETs). They could drastically reduce the amount of IHT due on your estate – but this strategy is not guaranteed to work.

The 7-year rule

If you do die within the seven-year window after a PET is made, the level of IHT due on these assets may be tapered – this is aptly called “taper relief”.

PETs are usually the first part of the estate measured against the nil-rate bands, so you are unlikely to benefit from taper relief unless you give more than the value of the nil-rate bands – such as gifting a property, perhaps.

Nevertheless, it’s important to understand how the rate of IHT may be tapered if these circumstances occurred.

Years between gift and death

Rate of IHT due

0 to 2 years

40%

3 to 4 years

32%

4 to 5 years

24%

5 to 6 years

16%

6 to 7 years

8%

7 years or more

0%

Source: HMRC

Calculating a potential IHT bill on your own is tricky.

With so many rules to be aware of, enlisting the help of a professional financial planner can help you keep track of how much you’ve given, what your potential IHT bill could be, and which allowances you’ve used up already.

Your annual exemption (and other gifting allowances)

Luckily, you do have an annual gifting exemption, meaning you can give up to £3,000 (spread over however many people you like) each year tax-free.

You can carry forward any unused annual exemption from one previous year – meaning your maximum annual exemption could stand at £6,000, or £12,000 if you and your spouse combine your exemptions.

Above £3,000 (or £6,000 if your annual exemption is brought forward from a previous year), the transfer is a PET, and could be caught by IHT if you passed away soon after.

There are some exceptions to these rules to be aware of. For instance, if you are giving money to someone getting married or entering a civil partnership, you can give the following amounts tax-free on top of your annual exemption:

· £5,000 to a child

· £2,500 to a grandchild or great-grandchild

· £1,000 to any other person.

There is also a £250 “small gift allowance”, in which you can give up to £250 to as many people as you like each year. Remember: people who’ve received money from you under another exemption can’t receive a tax-free £250.

Furthermore, the rules differ if you pay money as income rather than making one-off gifts. This can be complex, so make sure you speak to a professional if you plan to make gifts from income.

1. Using trusts to pass wealth to the next generation

Trusts are an important element of modern estate planning that can make all the difference to how you pass down your family’s wealth. Here are some common questions around trusts, answered.

What is a trust?

A trust is a legal arrangement, in which you can ringfence money and other assets (including property) for a specific purpose.

Money in a trust can be given before or after your death, depending on your wishes, meaning you can make a flexible estate plan that works for your family.

There are different types of trusts to choose from, including:

· Bare trusts

· Discretionary trusts

· Accumulation trusts

· Interest in possession trusts

· Mixed trusts

These all have different purposes and benefits, so it may be wise to talk them through with your beneficiary (your child, grandchild or other recipient) as well as a financial planner.

Why are trusts helpful in estate planning?

By placing assets in trust, rather than passing them down traditionally, you can usually:

· Reduce the amount of IHT due on your estate (more on this later)

· Be specific about who will receive the funds, over what time frame, and for what purpose

· Ensure your inheritance wishes are carried out after you’re gone.

Who looks after a trust?

When setting up a trust, one of the most important steps you’ll take is nominating a trustee.

This could be a friend, family member, or professional who is responsible for ensuring the trust funds are received by your beneficiary on time, and used for the purpose you intended. It’s important to nominate someone you know well who can take on this responsibility.

Can trusts reduce my beneficiaries’ Inheritance Tax bill?

Crucially, ringfencing funds within a trust can often mean your loved ones will pay reduced IHT. Usually, assets within a trust that exceed the nil-rate bands are subject to 20% IHT, rather than the usual 40% rate. There can be additional charges every 10 years, depending on the type of trust you hold.

Taper relief applies to trusts, too, so be careful of the seven-year rule you read about earlier.

It’s also important to note that if your beneficiaries receive trust funds as income, this may be subject to Income Tax at their marginal rate. Discussing the amount you plan to offer your loved ones with a financial planner can help you calculate the potential tax bill this could attract.

Is a trust a replacement for leaving funds in my will?

Ultimately, trusts are often set up as part of, not instead of, a full estate plan that thoroughly describes a person’s wishes.

While trusts are very useful for estate planning, you may have assets in your estate that fall outside trusts you’ve set up – so ensure the details of any trusts you hold are written into your will alongside everything else.

Secure your family’s future with the help of a Kellands financial planner

Estate planning can be both emotional and time-consuming, which is why so many people simply put it off. Yet procrastination could leave your family’s wealth vulnerable to unnecessary tax bills, and could place your loved ones in a precarious position down the line.

To discuss anything you’ve read about in this article, contact us today. Email us at hale@kelland.co.uk, or call 0161 929 8838.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.

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News & Views

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