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5 Simple Ways to Avoid Inheritance Tax in the UK
Inheritance tax is a punitive tax paid by a person who inherits property or money after a person dies. It weighs a hefty 40% which is more than twice the basic income tax rate. You can avoid the inheritance tax when you leave everything to your spouse or partner.
Want to know how to avoid inheritance tax?
In this post, we’ll discuss how to avoid inheritance tax in the UK.
1. Give Assets and Money to Family and Friends
The best ways to avoid inheritance tax in the UK is to give your assets and money to family and friends while you’re still alive. They (family and friends) should not be your spouse or partner. The assets and funds are only classed as gifts if you’re giving outright.
That means you’ll no longer be enjoying any benefit from the assets. It’s important to note that you are eligible to give away up to £3000 annually. If you fail to give out the £3000 this year, it carries over to the next year. This means you’ll be eligible to give out £6000.
Before the seven years elapse, do not give away more than the stated amount. You can give out civil and wedding gifts up to £1000 per person. This amount can increase for grandchildren up to £2500 and for great-grandchildren, £5000.
2. Set up a Trust
Another way to avoid inheritance tax in the UK is to set up a trust. A trust is a legal arrangement where assets such as stock, cash, artworks and real estate get transferred to a private fund. An individual or groups of individuals hold them for the benefit of the trust members.
Bear in mind that a trust does not have a separate legal identity such as a company. But if registered at a tax office, the trust fund will have its own tax reference. Also, it’ll be separate from the trustee’s personal affairs.
To create a trust, you need the help of a solicitor. At the solicitor’s office, you must have a list of assets and their values. Appoint a trustee.
Most people opt for a management company like a bank while others will choose an individual. It’s essential to select wisely as the trustee bears legal authority over the control of the trust fund.
Outline the terms for the trust that will be available in the trust deed. Determine the beneficiaries and the percentage entitled to each beneficiary. Once you create the trust fund and put your assets in the fund, they no longer belong to you.
3. Give Money to Charity
Like gifts to your spouse and partner, you can leave your assets and money to charity. For example, if your estate value is £400,000, you can leave £80000 to charity. If you do so, the taxman will not deduct inheritance tax.
Why you may ask. It’s because the total value of your asset after leaving money to charity will be £320,000. This is below the £325,000 inheritance tax allowance.
Another way to avoid inheritance tax in the UK is to leave 10% or more of your net estate to charity. This will reduce your inheritance tax rate from 40% to 36% or below. Let’s assume your total estate value before leaving money to charity is £600,000.
The inheritance tax allowance in the UK is £325,000. Your net estate value will be £275,000. If you choose to leave 10% of the net estate value to a charity, that means you’ll give away £27,500.
Many charities can benefit from your generous gifts. You can leave your money to cancer research, a hospital, the Red Cross or a relief foundation.
4. Spend More Money
One reason why people are wealthy is that they invest wisely and have good spending habits. If you spend less, you’ll accumulate money. This will help you build a decent portfolio of assets. While this is a good thing, it can create an inheritance tax liability.
To avoid inheritance tax, spend more income. Spending more income will improve your lifestyle and ensure that you pay less inheritance tax. Besides spending your income, you can spend your savings and capital.
Regularly accessing your savings and capital will reduce the value of your assets. On the other hand, it will stop them from growing over time. If you spend your savings and capital, you’ll avoid inheritance tax. Beware that selling certain assets may trigger other taxes such as capital gains tax.
In the UK, the capital gain tax rate on residential property is 28%. This rate applies to trustees and representatives of deceased persons. If the total taxable income and gains are below the income tax basic rate, the capital gains tax rate is 18%.
Remember, when spending your income, capital and savings, your goal should be to reduce inheritance tax liability not to run out of money. Do not deplete your assets quickly. To ensure this does not happen, we recommend working with a financial planner.
5. Use Your Pension Freedom
In 2015, the UK tax rules changed to provide people with greater access to their pensions. One of the major changes was to allow people to access their defined contribution pension. With this type of pension scheme, the final amount is dependent on the performance of your investments.
Traditionally, people bought an annuity with their pension savings. The annuity would pay a guaranteed amount. With Pension Freedom, you can access all your pension savings from age 55. You need to know that not many people are taking advantage of Pension Freedom.
If you want to avoid inheritance tax:
- Spend all your pension savings before you die. When you die, all unspent funds will pass tax-free to your spouse, children and grandchildren.
- Remember, you must set everything properly for this to work.
- Do not use your will to set up this arrangement.
All you need to do is make your wishes clear with your pension provider.
Final Thoughts
There are many options to help reduce or avoid inheritance tax in the UK. You can leave your money to charity, give gifts to family and friends or set up a trust. Remember, choose the right financial services that you can trust to help you handle your estate. I recommend choosing a financial adviser regulated and authorised by the FCA.
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