You have £1,000 in your hand, and only two choices of what to do with it. Either light a match under the notes, and watch them go up in smoke? Or put the money into your child’s moneybox?
Well, that’s not a difficult one. You would leave the matches in your pocket, and use the money for the benefit of your children!
But this is a simple situation, and the choices are clear. What happens in the real world, where things are a lot more complicated?
New figures show that many people are unwittingly seeing their money go up in smoke – or at least disappear into the pocket of the taxman - when the time comes to pass their estate on to their family. They do this by incurring a massive bill for inheritance tax (IHT).
The good news is that IHT has long been known as ‘the most avoidable tax of all’, because with good advice and forward planning, it can be minimised or even eliminated altogether.
Each person has a tax-free allowance (nil rate band) of £325,000, meaning that is the amount they can pass on to their children, free of IHT. Each partner or spouse in a family or civil partnership has this allowance, so that for a couple it doubles up to £650,000.
It sounds like a lot. But when you add up the value of your house, perhaps you might have a second or holiday home too, other assets, and life insurance not written in trust, you’d be surprised how it can add up. Anything that exceeds the allowance is potentially subject to IHT at a whopping 40 per cent before being passed on to your children.
Here’s just one example of how we may inadvertently throw part of our children’s inheritance away, if we don’t understand the rules around IHT.
NFU Mutual have revealed that many of us are failing to take advantage of a new tax break that was brought in last year.
The break, known as the residence nil rate band (RNRB), added extra tax relief when passing on the family home. The additional allowance provided by the RNRB is currently £125,000, on top of your £325,000 allowance. The RNRB is also rising, by £25,000 a year, until it reaches £175,000 in April 2020.
But the RNRB is not automatic – you have to check if you are eligible, and NFU Mutual point out that while 5,420 estates did receive the RNRB in April-July this year, thousands more did not, apparently through lack of awareness or failure to seek professional advice.
NFU’s experts point out that the rules around ‘the most avoidable tax of all’ are admittedly complex, and while there is great scope for minimising or avoiding the tax, you can’t go it alone. The guidance of a financial adviser is essential.
In addition to the RNRB and your standard nil rate band, there are a number of tools in the toolkit for ensuring you reduce the value of your estate for purposes of IHT.
The first step is to make a will that sets out your intentions in a way that gives you the best financial advantages. Another is writing your life insurance policies ‘in trust’, which removes them from your estate and lessens its value, thus protecting you from a preventable IHT liability.
There are a number of other arrangements that will ensure you pay no more than is absolutely necessary, when your IHT bill is eventually totted up - and as I say, with some savvy planning you may quite possibly avoid paying a penny.
However, as our friends above who missed out on their RNRB allowance will tell you, you have to sit down and get the correct measures in place. One hour with a financial adviser could be the most well-paid hour of your life, when you see how much you’ve saved.
So put your matches away, and avoid lighting dangerous fires! I’ve said it before: burning your money with unnecessary tax payments is for people who love the taxman more than they love their own children!
:: Michael Kennedy, an independent financial adviser and pensions specialist, can be contacted on 028 71886005. More information on Facebook at Kennedy Independent Financial Advice Ltd or at www.mkennedyfinancial.com
