Inheritance and passing your money on
Read our guide for information on wills, inheritance tax and making sure your loved ones get your hard-earned money and not the taxman.
In 2010 the UK Treasury benefitted to the sum of £53m(1) from people not writing a will (Intestate), meaning that the law gets to decide who gets what and when. Research by Standard Life in 2011 shows six out of ten UK adults 61%(2) don't currently have a will. Inheritance Tax (IHT) at 40% is charged on the value of your estate in excess of the nil rate band when you die. As the nil rate band is currently £325,000 you would leave an inheritance tax bill of:
Whether your estate's worth £100,000 or £1,000,000, here's how to pass it on tax-efficiently and according to your wishes.
Sheila McCain, 67
"Why I recently revisited and changed my will."
Updating a will
Sheila McCain, 67, lives in London with her partner John.
"I recently revisited my will," says Sheila. "The first one was written when I was in my 40s and much has changed since then. I'm now divorced and have five lovely grandchildren."
"There's a further complication, too, as John and I aren't married, which means we don't have the legal rights that married couples have when it comes to inheritance. Having our wills written gives us the reassurance that, whatever happens, our wishes will be followed."
As well as arranging her will in the UK, because Sheila has a property in Tuscany, she also needed to have a will written in Italy.
"The Italian legal framework is very different and, without a will, everything in Italy would have passed to John's eldest son. This wasn't what we wanted so we arranged wills in Italy to save complications," she adds.
The thought process behind the wills also made Sheila think about her inheritance tax position. "I'm looking to take advantage of the exemptions wherever possible. As an example I gave my son and his wife a gift when they got married recently. It's much nicer to see people enjoy it than to leave it for the taxman."
Almost 60% of adults don't have a will according to a survey by children's charity Barnardo's(2). A will is an essential part of your financial planning. Not only does it set out your wishes, but, die without a will, and your estate will generally be divided according to the rules of intestacy, which may not reflect your wishes.
This can be particularly problematic for unmarried couples, as the surviving partner doesn't have any automatic rights to inherit, but it can also create problems for married couples and civil partners.
As an example, if you live in England and are married but don't have any children and your estate is worth more than £450,000, only the first £450,000 plus personal possessions and half of the remaining estate will automatically pass to your husband or wife. Anything else will go to your parents or, if they're not alive, your brothers and sisters and their children. Only if your estate is worth less that £450,000 will your spouse/civil partner receive the whole of your estate.
If you lived in Scotland under the same circumstances, your spouse would only be given the full house value if it was less than £473,000, furniture to the value of £29,000, a cash sum of £89,000 and a third of the remaining estate. Anything else would go to your parents if they were still alive, or your brothers and sisters and their children if not.
You can write your own will but this is rarely recommended unless your affairs are exceptionally straightforward. Instead it's worth seeking professional advice from a solicitor or will writer.
They'll ensure you consider everything and suggest the best way to divide your estate. For example you might want to give set amounts to some people but leave a percentage to others.
The will writer will also make sure your will is legal. This includes checking you're not under any undue pressure to write your will and that there are two witnesses, who can't be beneficiaries.
While a will helps to ensure your estate is distributed according to your wishes, the IHT rules mean that one of your beneficiaries could be the taxman.
Your estate is made up of everything you own minus any debts such as mortgages, loans and your funeral expenses. If the value of your estate exceeds the IHT nil rate band (currently £325,000), the surplus will be taxed at 40%.
An extra rule applies to married couples and civil partners. The transferable nil rate band means that the surviving spouse or partner can use any of their partner's unused nil rate band (NRB). As an example, John dies in 2011, leaving all of his estate to his wife Mary. When Mary dies the NRB is still £325,000, but the NRB available to her estate is £650,000 (Mary's NRB of £325,000 plus 100% of the NRB as the proportion John had not used).
Having paid tax throughout our lives, few of us want to leave the taxman more when we die and there are a number of ways to reduce the amount he receives.
Giving away your estate can be an effective way to reduce a future IHT liability.
- Exempt Transfers: these are gifts where IHT will never be payable.
- Potentially Exempt Transfers: these can become exempt from IHT if you survive for seven years from when you make the gift.
- Chargeable Lifetime Transfers: these may incur an immediate IHT charge of 20%. Further IHT may be payable if you die within seven years of making the gift.
To avoid making a Gift with Reservation, which will not reduce your estate for IHT, you must give the asset you are gifting away completely. If, for example, you gave your car to your son or daughter, but still use it from time to time, the taxman could class this as a Gift with Reservation and it would remain within your estate for IHT purposes.
You can find out more about IHT allowances at www.hmrc.gov.uk.
Sometimes giving money outright might not be the best solution. For instance you might want to give money to a child, but be worried about how they might spend it: or you might want to leave some money for grandchildren, but do not yet know how many you'll have.
In these situations, a trust can be a good option. These can allow you to reduce the value of your estate but retain some control over who receives the gift and when.
A number of ready-made trusts schemes are available including gift plans,discounted gift plans and loan plans. How these work and their tax treatment varies so it's sensible to seek financial advice when considering these options.
If you have a large amount to give away or your situation is particularly complicated, you could have a trust tailor made for you. A solicitor will be able to do this but there will be additional costs involved.
You can find out more about trusts at www.direct.gov.uk.
If it is likely that IHT will be payable on your estate, a whole of life policy can be used to ensure that funds are available to pay all or some of any future IHT bill.
Provided you pay the premiums, the proceeds of the policy will be paid to your estate when you die. It is vital to have the policy written under trust to ensure that the money paid out by the policy is outside your estate. This then ensures that the money can be used to settle the IHT tax bill and not add to it.
In certain situations, a lump sum may be payable from a pension plan when the member dies. Depending on the scheme rules it may be possible for the member to nominate an individual or a trust to receive this lump sum and to make this payment tax efficient.
- Make a will and review it regularly. Writing your will is a simple and effective way of ensuring your estate is distributed according to your wishes.
- Work out your potential inheritance tax (IHT) liability and then review regularly to make sure you keep up with allowances and legislation. Your IHT liability is 40% of anything over the nil rate band (currently £325,000).
- Make use of IHT exemptions as these can help you reduce the value of your estate. These include regular gifts out of income and your annual allowance.
- Consider a trust arrangement which can be used to allow you to retain some control over a gift. This might be worth considering if you want to leave money to children or for future grandchildren or great-grandchildren.
- Grant a Power of Attorney. This should ensure your affairs can be managed even if you are not able to do so yourself.
A few simple steps can make sure you pass on your estate tax-efficiently and according to your wishes.
Important information and assumptions
References to legislation and taxation are based on Standard Life's understanding of law and HM Revenue and Customs Practice. Legislation and taxation are liable to change in the future. All figures relate to the 2011-2012 tax year, unless otherwise stated.