There are various ways that you can deal with your money, property and estate in order to avoid your heirs paying inheritance tax (IHT).
One of the ways you can avoid IHT is by either spending or giving away a significant proportion of your wealth during your lifetime. You can make several different kinds of gifts during your lifetime that are exempt from IHT.
Potentially Exempt Transfers
While other gifts that you might make don’t automatically come under the tax-free list, they might become tax-free if you live for seven years after making the gift.
These are called Potentially Exempt Transfers (PETs). Most gifts that are made to people, rather than trusts or companies, come under the PET category.
If your estate is mostly tied up in houses or other forms of property, you might not be able to access it in order to make gifts or spend during your lifetime.
In order to work around this, you can take out an equity release scheme. This means that you will be borrowing money against your home’s value (also called a lifetime mortgage) or you will be selling part of your home at a reduced rate, while you stay living there (also called a home reversion scheme).
If you take out one of these schemes and release money, then you can pass it on as a gift to your heirs, as long as you live for seven years longer after making the gift. If these criteria are met then no IHT has to be paid.
What happens when you die?
If you have a lifetime mortgage then your estate will be reduced by the debt when you die. Although releasing equity this way is tempting, think carefully before you decide to take out a scheme.
Lifetime mortgage interest is ‘rolled up’, meaning your debt will grow fast. As an example, take a look at a £50,000 mortgage with a 7% interest rate per year. This will almost double to £98,358 within a decade. So, you could end up owing more to the mortgage lender than the IHT would have been anyway. It’s always worth consulting an expert if you are considering this route.
Life insurance trust
If you have a life insurance policy and you want it to specifically go to your heirs when you die, then you can put the policy into trust.
These won’t count towards your estate when HMRC works out your IHT. They will also be paid before probate is granted, which means your heirs will get the money much faster.
Deed of variation
This gives your heirs permission to change your will after you die. It could be used to redirect part of the inheritance to someone else, for example. A deed of variation can be drawn up within two years after you die, but all of the will’s beneficiaries have to be in agreement.
Insure against IHT
This is perhaps the simplest way to deal with the IHT bill, but it’s expensive if you’re still young. If it is too expensive, you could consider having your heirs paying the premiums, as they will ultimately benefit.
It works by you taking out a ‘whole of life’ insurance policy. The policy should pay out enough to cover the IHT. The policy is written under trust, and so is paid free of IHT before probate is granted.
HMRC will consider the premiums paid to the policy as a ‘lifetime gift’ if they’re paid by you. They can normally be covered by one of the tax-free exemptions as well.