Whilst it might be stretching a point to say that your estate planning strategy should be handled with military precision, it certainly pays to be organised and leave nothing to chance when you are getting your affairs in order. The plan doesn’t necessarily need to come together in one go, or be set in stone.
Circumstances and priorities change – which is why the most effective planning entails a fair degree of flexibility.
As your estate plan develops and evolves, however, you’ll always want to keep in mind how best to:
• Keep taxes to a minimum
• Provide adequately for your spouse and other beneficiaries
• Ensure your affairs are properly dealt with, if you are incapacitated
• Donate to charity
On minimising tax, the spectre of inheritance tax (IHT) is one that often looms large and is one area definitely worth preparing for.
IHT in the UK
Although every jurisdiction is different, many onshore jurisdictions will have a form of IHT, which is normally levied on death. This is unlike offshore jurisdictions, such as the Isle of Man, where there is no IHT. For the purposes of this article, if you are domiciled in the UK, all your worldwide assets will be subject to IHT. Currently the rules are that the first £325,000 is tax exempt, thereafter any assets over this figure are taxed at 40%.
For anyone married or in a civil partnership, you can double up on your inheritance tax threshold, or nil rate band, to £650,000. Transfers between spouses are tax-free for inheritance tax purposes, so you can freely give all your assets to your spouse on your death. In this scenario, no inheritance tax is payable. On the death of the second spouse, the combined estate will be taxed above the £650,000 threshold.
With more and more estates becoming liable to IHT – leading to growing numbers of beneficiaries being saddled with unexpected and often sizeable tax bills – what can be done to cushion the financial blow, so that estates are kept intact as much as possible?
One simple answer is to move lock, stock and barrel to an offshore jurisdiction, such as the Isle of Man, which happily doesn’t have any IHT. But, as cut and dried as that may sound, for many it’s not always a practical solution to relocate – however enticing the advantages might be.
Leaving aside the considerable estate planning scope of trusts and foundations (covered in previous articles), one useful and effective form of protection against IHT is to take out a Whole-of-Life Insurance policy. The reasons for doing so are numerous but, fundamentally, if you believe your nearest and dearest will be faced with an IHT tax liability and your home may need to be sold to pay an IHT bill upon your demise, then that would be justification in itself.
• Your heirs get to keep most of their inheritance
• Reducing the value of your estate – a whole-of-life policy has a double benefit because the proceeds of the policy fall outside your estate for IHT purposes and the premiums paid also reduce the estate value during your lifetime.
• Protecting Assets – Your estate is vulnerable to repossession. Similarly, your assets may be lost if your heirs need to sell them to pay the tax bill. If you want to prevent the fruits of your labour and family heirlooms from falling into the hands of strangers, inheritance tax insurance is the answer.
• Clearing Your Debts – a whole-of-life insurance payout can be used to eliminate any debts you incurred during your lifetime.
• If you’ve made gifts to friends and family in the last seven years, these gifts could still be included within your IHT liability. Insurance can mitigate the costs of this happening.
• Covering funeral expenses – funerals can be very expensive these days. IHT insurance can cover the cost.
But before you think that an insurance policy is the ultimate panacea which will offset IHT altogether – it isn’t. It is more a way of ensuring any IHT liability is funded when you die. A whole-of life-insurance plan will pay out a lump sum upon your death and pay any tax due at the time.
This should enable your relatives to receive their anticipated inheritance, safe in the knowledge that the policy has paid all the tax that is due – but be mindful to write this policy in trust to ensure that the tax situation doesn’t deteriorate.
Of course, by taking out a whole-of-life insurance, there is going to be a cost to the cover. And the older you are, and the longer you delay, the more expensive the policy will become. Set against this, the main benefit is that it will provide a simple, peace of mind solution and leave you fully in control of your assets while you are alive.
An alternative to a whole-of-life policy is to give away part of your estate before you die. However, if you die within seven years of the gift, there could still be an IHT liability, as most gifts are deemed ‘potentially exempt transfers’ (PETs) for those seven years. The good news is that as more time elapses, the less tax is due, as the tax due on a PET reduces, or is ‘tapered’ over the 7-year period. This makes a 7-year decreasing-term policy an effective and cheaper way of covering any potential IHT liability.
Whilst life insurance isn’t the only way to mitigate against IHT, it can prove to be a very useful tool in your armoury – not that we want to be too militaristic about this!
Watch out for further articles on estate planning strategies and ways of avoiding inheritance tax.