The situation we find ourselves in is an unfortunate one for many. However, the majority of us have gained some extra time in our lives from somewhere. Be this the time you would usually spend in your car or on a train to work, in restaurants and bars or at the gym, you probably have a few hours a week you usually wouldn’t. So, why not use this time to do the things you may have been putting off?
One of the areas of financial planning that people are most likely to put off dealing with is inheritance tax planning and wills. Perhaps because no one likes to contemplate their own mortality, more than 50% of people have no will in place and have not made any plans regarding their estate. Given the current situation, now would be a prudent time to think about these things. The difficulty it causes your loved ones should the worst case happen to you and you have not sorted this out, can be huge.
Inheritance tax is 40% on anything over £325,000 on your worldwide assets. It is a hefty tax that is often considered voluntary, as it can quite easily be planned for. Many people living overseas wrongly assume they are not liable, so understanding the difference between non-resident and non-domiciled is essential.
Most UK expats will remain UK domiciled even if they have lived abroad for many years. They may also be liable to estate taxes in their country of residence and will almost certainly have assets which are liable to be charged to estate duties in their country of situs. Without planning all three could bite and wipe out the entire value.
There are 5 types of domicile:
Domicile of Origin
This is your initial domicile, acquired at birth. It isn’t dependent on citizenship; rather you acquire your father’s domicile (or mother’s, if your parents were unmarried at the time of your birth). For example, if your domicile is the UK but your children were born here in the UAE, they have British citizenship and their domicile is the UK. However, if your children were born in the US, they will have dual citizenship, but their domicile will be the UK.
Domicile of Dependency
Until the age of 16, a child is considered a dependent and his/her domicile will change along with his/her parent’s.
Domicile of Choice
After the age of 16, it’s possible to acquire a new domicile. However, it isn’t automatic, nor is it a straight-forward process. You must be able to provide evidence that you have “abandoned” your domicile of origin, that you have physically moved to and reside in the new locality, and show intent to remain in your chosen domicile permanently. Some of the factors taxing authorities (and courts) consider to determine your “intent” are:
- Amount of time you spend in one location versus another
- Location of your spouse and children
- Location of your principal residence
- Where your driver’s license was issued
- Where your vehicles are registered
- Where you maintain your professional licenses
- Where you are registered to vote
- Location of the banks where you maintain accounts
- Location of your real property and investments
- Permanence of your work assignments in a location
- Location of your social ties
If you retain significant ties with your domicile of origin, it’s unlikely that you’ll be able to acquire a domicile of choice. The tax man won’t let you get away easily!
In the UK, if a “non-dom” has been UK resident for 15 of the previous 20 tax years, he/she becomes deemed UK domiciled for all tax purposes.
In the UK, a non-dom married to a UK domicile person can elect to be treated as a UK domicile for UK Inheritance Tax (IHT) purposes.
What are the implications of your domicile?
It is key to any financial plan to know your residency and domicile status, in order to determine your tax liabilities in three main areas: income tax (from investment or employment), Capital Gains Tax and IHT.
For example, someone who is a UK elected domicile will be entitled to full spousal exemption; the married couple can transfer assets between themselves to mitigate their IHT tax liability. IHT will only be payable on the second death.
Once you have established your domicile status, the next step is to plan for inheritance tax. So what can you do?
1. Leave everything to your spouse/partner.
If you’re married or in a civil partnership, you can give anything you own to your spouse or civil partner (unless your spouse was born outside the UK, in which case the amount you can give away might be limited), so your estate will not have to pay Inheritance Tax. There are different rules if your spouse or civil partner’s permanent home is outside the UK. The rules are very complicated so it is extremely important you take advice if this is the case.
The issue with this is that the Tax will then be paid when the spouse/partner dies making it really only a temporary solution.
2. Gifting it away.
If you give something to a friend or a family member who is not your spouse or civil partner, so that you no longer get any benefit from it, the value of the gift will still be included in your estate for Inheritance Tax – but only for the following seven years. So, for example, if you give one of your children some money, and you live for a further seven years, it won’t be taken into account when calculating the Inheritance Tax liability when you die. You can give away limited amounts every year and not have to pay Inheritance Tax. For example, you can give away up to £3,000 a year and you can give away money to your children and grandchildren when they get married.
Just be aware that there might also be Capital Gains Tax to pay on certain assets that you give away in your lifetime.
The issue with this is that there is no guarantee you will live for the next 7 years.
3. Leave something to charity.
Anything you leave to charity is free of Inheritance Tax so it can be a useful way of reducing your Inheritance Tax bill, while benefiting a good cause. And if you leave at least 10% of your estate to charity, it will cut how much Inheritance Tax is due on the rest. The rate at which Inheritance Tax is calculated is 36% rather than 40%. This rate is set against the balance of the estate to the extent that it exceeds the available nil-rate band. This might not be a huge saving, but it can mean that family and friends will receive more than they would do otherwise – while your favourite charities also benefit.
4. Use a life insurance policy to cover the inheritance tax bill.
If you take out a life insurance policy, it won’t reduce the amount of Inheritance Tax due on your estate. But the payout might make it easier for your surviving family to pay the bill. It could mean that they are able to prevent the family home from being sold. If you do this, make sure the life insurance payout goes into trust – if you don’t it will make your estate bigger and it thus have to pay more tax.
5. Put things into Trust.
If you put some of your cash, property or investments into a trust (which you, your spouse and none of your children under 18 years can benefit from), they’re no longer part of your estate for Inheritance Tax purposes. For example, you could set up a trust for your adult children, to pay for your grandchildren’s education, or support a family member with a disability. You can set up a trust right away or you can establish one in your will. Since the assets are no longer technically yours, they are not liable for IHT. Trusts are an extremely complex part of financial planning with a large number of different types and formats of trust, so we recommend that advice is always sought before any trusts are put in place.
There are other planning techniques and products which can be extremely useful to eradicate or minimize worldwide estate taxes.
What is clear is that doing nothing should not be an option. If you care about your family and prefer your loved ones to enjoy the fruits of a lifetime of hard work, planning is vital. If you prefer to volunteer large amounts of money to assist the revenue services of various countries around the world, there is no need to do anything.