Tax Efficient Wills

What is a tax efficient Will?

Essentially, you should ensure that all Inheritance Tax allowances can be claimed by your beneficiaries.

People may have made wills before 2007 and included a Nil Rate Band Discretionary Trust to save Inheritance Tax. But that’s not necessary any more, because there is no tax between spouses now.

However, if you have left everything in your Will in a Trust, and your assets are over £325,000 when you die – or joint assets of £650,000 for a couple – the children do not get the additional residence nil rate band allowance that George Osborne introduced, with the intention of allowing them to inherit up to £1 million pounds tax free.

So ensuring that your Will enables all Inheritance Taxes allowances to be claimed is what you might consider to be a tax efficient Will.

Our solution is to create two Trusts in the Will. All assets are protected on first death. The first Trust ensures that the children directly inherit assets up to the value of the Residents Nil Rate Band. The second Trust protects the residue from being lost if the children get divorced or become bankrupt and can save Inheritance Tax on a generational basis. This means the children can claim both residence nil rate band allowances and can still inherit up to £1 million tax free.

Can you avoid Inheritance Tax by making a Will?

You can write tax efficient Wills, which save Inheritance Tax, but you’re not necessarily going to allow your children to inherit everything tax free.

But if you create a Trust in your Will, the Trust can carry on for another 125 years. So your children can leave your assets to your grandchildren tax free.

So what if your children inherit from you directly and they are already over the Inheritance Tax threshold? In these circumstances, they may have to pay Inheritance Tax on your assets, even though they’ve already been taxed.

A Will can save Inheritance Tax on a generational basis. The Trust created by the Will can last for up to 125 years, and the assets can be passed down the generations without incurring Inheritance Tax. With the right advice, Trust wills can be a suitable vehicle for saving tax, but advice should always be sought and other options considered as well.

One also has to be aware that if there’s more than £325,000 in the Trust that’s created by your will, there can be a 10 year anniversary charge of a modest amount, perhaps 6% of anything above that £325,000. It therefore means that two parents can leave £325,000 each for future generations, without this 10 year anniversary charge being levied.

So two parents can leave £650,000 for 125 years without any Inheritance Tax being payable under the current rules.

How much can I be left in a Will without paying tax?

If you’re a single person, you automatically have an allowance of £325,000. If you have children or grandchildren or adopted children, you can leave another £175,000 free of tax on the condition that you’re leaving your children the proceeds from the sale of your home, or part of the actual home.

That means you can leave a total of £500,000 free of Inheritance Tax. A married couple or civil partners can leave twice that amount – £650,000 between them. And, if they owned a home at one time and are leaving £350,000 or more to their children or grandchildren, then they can leave £1 million tax-free.

In other words, if you have been a homeowner and your total assets are between £650,000 and £1 million, everything should be tax-free, as long as you’re leaving at least part of your estate to your children or grandchildren.

Can I put my house in my children’s name to avoid Inheritance Tax?

It’s a common thought. Some have heard it’s a good idea to put their home into their children’s names to avoid Inheritance Tax. But no professional adviser with any credibility would ever recommend that.

What would happen if your child became bankrupt or got divorced one day, or succumbed to drugs or gambling? If you’ve given your home away to that child or children, you could find the courts taking it away and you being left on the streets.

Just to reinforce what a bad idea it is, in nearly every case, if you give the home you’re living in to your children, it would not save Inheritance Tax. This is because of Reservation of Benefit rules.

HMRC would see that you’ve transferred the property into your children’s name, but because you’re still living in it, it is a gift with Reservation of Benefit – or a GROB, as solicitors call it.

Placing a house into the children’s names does not avoid Inheritance Tax unless you want to pay full market rent to your children. And in that case your children would have to pay tax on the rent they receive. When you do the sums, it doesn’t add up. It’s not a suitable way to try and save Inheritance Tax.

What is the most tax efficient way to leave a home to a child?

It really is to leave it in your Will. You’re allowed to leave £325,000 worth of assets tax-free. And if you leave your home to your children, you’ve got another £175,000 allowance – that’s £0.5 million per person.

So if you’re a married couple, you can leave the family home and other assets up to the value of £1 million tax-free to your children.

If you’re lucky enough to have assets worth over £1 million, you might want to consider making gifts during your lifetime.

How does gifting money work?

We have to consider the seven year rule. You can actually gift any amount of money to your children or anyone with no tax at all when you make the gift. However, if you die within seven years of making the gift, it will be included in your estate and will be taxable.

There are certain amounts of gifts which would not be taxable even if you did die within seven years of making them. Those are gifts of £3,000 per person, per annum, made within seven years of the date of death.

You can make any number of other gifts up to £250 per person each tax year, as long as you’ve not used another allowance on the same person. Birthday or Christmas gifts you give from your regular income are exempt from Inheritance Tax. You can also make gifts for weddings or civil partnerships.

Each tax year, you can give a tax free gift to someone who’s getting married or starting a civil partnership. You can give up to £5,000 to a child free of Inheritance Tax potentially, or £2,500 to a grandchild or great grandchild, £1,000 pounds to any other person.

You can combine a wedding gift allowance with any other allowance except for the small gift allowance. So, for example, you can give your child a wedding gift of £5,000 as well as the £3,000 gift from your annual exemption in the same tax year.

So you shouldn’t feel that there are limits as to what you can gift to save Inheritance Tax. But for older people who are considering regular tax-free gifts, and not knowing when they’re going to die, they can make regular payments out of taxed income of as much as they wish.

This is quite an interesting concept for those who haven’t heard about it or thought about it.
You can make regular payments to another person, for example, to help with their living costs. There’s no limit to how much you can give tax-free, as long as you can afford the payment after meeting your usual living costs yourself, and you pay it from your regular monthly income.

These are known as ‘normal expenditure out of income’. It could include paying rent for your child, paying into a savings account for a child under 18, giving financial support to an elderly relative, or even contributing to a child or grandchild’s pension contributions.

You’d have to make the payment to the child or grandchild, direct to their bank account, and they would then use that money to put into a personal pension – on which they get tax relief at source. They can also receive a certain amount of it tax-free when they retire. It’s a really good way of saving a loss of tax, and the money you’re giving stays in the bloodline for a long time.

If you’re giving gifts to the same person, you can combine normal expenditure out of income with any other allowance, except for the small gift allowance. For example, you can give your child a regular payment of, say, £60 a month as well as using your annual exemption of £3,000 in the same tax year. The £60 a month is a random amount – it could be whatever you wish.

Can you explain a bit more about the seven year rule?

No tax is due on any gifts if you live for seven years after giving them, unless the gift is part of a Trust. You need advice if you’re going to make gifts into Trust.

This is known as the seven year rule. If you die within seven years of giving a gift, there may be Inheritance Tax to pay on it. The amount of tax due after your death depends on when you gave it.

But I don’t want people to think that if they give a gift within six, five, or four years of dying, it could be outside of their estate. Taper relief, which I’m going to talk about, only applies if the total value of gifts made in the seven years before you die is over the £325,000 tax-free threshold.

So it’s really for people with a lot of money to give away that might get taper relief if gifts are made within seven years of dying. This taper relief applies on gifts given in the three years or more before your death.

Gifts given three to seven years before your death are taxed on a sliding scale – known as taper relief. I’m not going to go into too much detail, but just be aware of that. It’s often misunderstood – because it only applies if the total value of gifts made in the seven years before you die is over £325,000.

Do I have to inform HM Revenue and Customs if I inherit money?

If there is tax to pay, yes. It’s a legal requirement and you could get into trouble if you don’t.

But if the estate is less than £325,000, you do not need to inform HMRC. If the estate is between £325,000 and £650,000 and comes from the surviving parent, no tax is due and technically you do not need to inform HMRC.

But if you want to claim this residence nil rate band allowance that George Osborne introduced, you must go through the process of applying for probate and claiming the allowance within two years of the second death, or the death if it’s a single person. Really, you need to take advice if the estate is above £325,000.

When do I have to pay Inheritance Tax?

When someone dies, you are responsible for paying the Inheritance Tax if you are named as an executor in the Will.

If there is no will and you’re a beneficiary, you decide who is going to obtain what’s called Letters of Administration. It’s the same thing as a grant of probate, in effect. But essentially, Inheritance Tax needs to be considered and potentially paid when someone dies.

How can Will Power help?

You can always go and listen to our probate podcast, which covers a lot of burning questions about what would happen when someone dies. It also explores when to pay Inheritance Tax and how to go about it.

We have a number of other podcasts now which will answer many other questions you might have.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.

Tax treatment varies according to individual circumstances and is subject to change.