Estate and inheritance taxes are broadly similar because both are generally triggered by death. Estate taxes are levied on the net value of property owned by a deceased person on the date of their death. In contrast, inheritance taxes are levied on the recipients of the property. Both of these taxes are generally paired with some kind of gift tax so that they cannot be avoided by simply transferring the property prior to death.
Many countries levy taxes on estates or inheritances, including France, the US, UK, Spain, Ireland, with Japan having the highest top marginal rate at a whopping 55%.
In the UK, Inheritance Tax (IHT) is paid on the value of the deceased’s estate, at the rate of 40% on the value above your available Nil Rate Band (NRB), currently GBP 325,000.
Most people retain their domicile, even if they have been living abroad for a prolonged period. It’s a common misconception among UK expats that only UK assets will be subject to UK IHT. The UK tax system, like others, operates on a worldwide basis. This means a deceased person’s worldwide estate will be subject to IHT. An expat may also be subject to the inheritance tax laws of foreign countries in which they hold assets. There are also different rules around non-domiciled spouses and partners. That’s why it’s important to be clear and up-to-date on your estate planning with an expat will.
Before probate can be granted, the probate fee and any inheritance tax due on an estate must be paid, so there could be a significant bill for beneficiaries to pay before they can access their inheritance. Setting up a life insurance policy could help ensure your beneficiaries have access to cash to pay all required fees.
But there are other ways to go about it. Lord Roy Jenkins – a former chancellor of the exchequer – described inheritance tax in a 1986 Commons debate as “broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.”
Voluntary because there are measures that can be taken to limit liability to IHT, including:
1. Spouse and civil partner exemptions
Gifts and transfers between most married couples and civil partners living in the UK are IHT-free. It is possible for the survivor to inherit the percentage amount of unused NRB from their deceased spouse. The IHT liability will arise when the second partner dies.
2. Annual exemption
Every person is allowed to make an IHT-free gift of up to £3,000 in any tax year – double the amount for a couple – and this allowance can be carried forward one year if you don’t use up all your allowance.
3. Gifting and other exemptions
You are able to make small gifts of up to £250 per year to anyone you like.
There is no limit to the number of recipients in one tax year, and these small gifts will also be IHT-free, provided you have made no other gifts to that person during the tax year.
Lifetime gifts are those made by you while you’re still alive. If such gifts are made to help with another person’s living costs, e.g. an elderly relative or child, they are free from IHT.
Other lifetime gifts may be exempt as long as you make them regularly (e.g., annually), and they come from your regular income, (such as pensions, dividends, interest from investments etc.), without affecting your lifestyle – however, this is subject to the tax man’s interpretation, so it is important to document your intentions and keep a record of this with your will.
If someone you know is getting married or entering into a civil partnership, you can give them a financial gift IHT free (up to £5,000 to a child, £2,500 to a grandchild or great grandchild and £1,000 to others).
4. IHT-free bequests
Gifts or bequests to charities, political parties, universities and for national purpose or public benefit are IHT exempt.
5. Potentially Exempt Transfers
A PET is a gift of any amount to anyone. The only conditions for it to be tax-free are that it is made more than seven years before death and the gift is “without reservation”, an outright gift. A parent, for example, cannot give away the family home and then continue to live in it and think they have found a clever way to avoid IHT.
Even if the donor fails to survive the seven years, PETs can still be worth making as tax may be paid at a reduced rate.
6. Invest in a pension
A pension is one of the most tax-efficient ways to escape IHT. Your pension won’t be subject to Inheritance Tax as it never becomes part of your estate. This has made pensions a useful estate planning tool. You could potentially save Inheritance Tax by leaving your pension untouched and funding your retirement with other assets that do form part of your estate.
7. Set up a trust
Estate held within a trust falls outside of IHT. There are many options for trusts and other structures, wrapping assets and investments like an offshore investment bond inside.
Finally, you can spend your wealth. Those who chose to spend their wealth are now called the Ski – or Spending the Kids’ Inheritance – generation. The danger is that too much gets spent, leaving little for later retirement. It is much safer to be Owls – oldies withdrawing loot sensibly.
With so many options available to reduce your beneficiaries’ future liability, some that can span years, it really is prudent to start (or update) your estate planning now.