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Three common DIY inheritance tax planning mistakes that could cost you dear

Paloma Kubiak
Written By:
Paloma Kubiak
Posted:
Updated:
27/04/2023

You may think you know inheritance tax or you may want to go it alone without financial help, but some of the most common DIY decisions can cost you thousands or even hundreds of thousands of pounds.

Inheritance tax receipts continue to surge, with more and more estates falling under its scope.

In the last year, £7.1bn was paid in inheritance tax (IHT), up by £1bn over the 12 months.

IHT used to be seen as a ‘niche’ tax levied on the wealthiest, but now, many would say ordinary people are increasingly being drawn into its net as thresholds have remained frozen.

Families may be tempted to make big financial decisions without advice in the belief they will save IHT.

But Rachael Griffin, tax and financial planning expert at Quilter lists three common DIY IHT mistakes you should avoid and the legitimate ways to get round paying this hated tax:

1) Gifting your home to children

The mistake here is not understanding the ‘gift with reservation’ rules.

A big mistake some people make when it comes to IHT planning is gifting their homes to their children, continuing to live there without paying rent, and then being caught out by the gift with reservation rules.

While it is possible to avoid inheritance tax by surviving for seven years after you gift your home to your child, this benefit can be lost if you are not aware of the rules surrounding gifts with reservation and you continue to benefit by living in the home rent free.

If you wish to mitigate IHT and want to continue living in your property after you have given it away, you will need to pay the going rate of rent and pay your share of the bills. If you do not meet these requirements, it will count as a ‘gift with reservation’ and will be added to the value of your estate when you die meaning IHT may be payable.

What’s more, the value will be the market value of the property at your date of death, not when you ‘tried’ to make the gift. As house prices rise, this can be quite significant in terms of the level of IHT due.

IHT planning is a complex area, particularly when it comes to gifts with reservation, so it is important to seek professional financial advice to ensure you are making the best, most tax efficient choices for your individual circumstances.

2) Not writing a will

The mistake here is it could mean your wishes are not met.

One of the costliest mistakes you could make in terms of IHT is not having an accurate and up-to-date will in place. This is ultimately the starting point for sound financial planning, but far too many people do not have one – or they have a DIY will that is too simplistic and may not be considered legally valid. If someone makes a will but it is not legally valid, the rules of intestacy decide how the estate will be shared as opposed to the wishes included in the will.

Intestacy rules provide protection only to those married or in a civil partnership and guarantees that the remaining partner receives all the deceased’s personal items and their estate up to the value of £270,000 (plus half the excess over £270,000) if they had children or grandchildren, or the full estate if they did not.

When someone passes away without a will, they die intestate and their estate is usually administered by the next of kin. The administrator is unable to divide the estate up as they wish and must instead stick to the UK intestacy rules. Without a will, cohabitees in particular risk not automatically inheriting anything on the death of their partner unless they jointly own property.

3) Failing to plan ahead tax efficiently and not keeping records

The mistake here is not discussing your wishes and understanding allowances.

Failing to plan effectively to ensure you are passing on your wealth in the most tax efficient way can result in your hard-earned money going to the taxman unnecessarily.

There are many options available when it comes to passing on your wealth tax efficiently, be that in life or in death, yet many people do not make the most of them and could pay more in IHT as a result. It is wise to talk openly with your family and consider these options together sooner rather than later to ensure you make the most tax efficient decisions possible. What’s more, when you make these decisions it is important to keep accurate records to ensure you can make the most of what is available and that your wishes are fulfilled.

IHT was once viewed as a tax on wealthier individuals, but the reality is that more people are now getting caught in the IHT net – particularly as a result of increased property prices – so it is vital to plan ahead.

In the current climate, many people will be keen to support the younger generations of their family to help ease cost-of-living pressures. If this is the case, it is important to be aware of the allowances available to make sure you make tax efficient choices for your own finances while also supporting others.

There are several options available that can be particularly useful if you are keen to provide for your loved ones without giving them large amounts of cash. For example, any gifts you make – as long as they are made at least seven years before you pass away – are tax free, and you have a tax-free gift allowance of £3,000 per year. As a couple, you can combine these allowances to give you £6,000. You can give these gifts or money to one person or split the allowance between several people.

Additionally, the small gifts allowance means you can give as many gifts of up to £250 per person as you want each tax year, as long as you have not used another allowance on the same person. You are also free to make additional payments that are not liable for inheritance tax if they are regular and use excess income.

When planning how to pass your wealth to those closest to you, be that in life or once you have passed away, seeking professional financial advice and having an open conversation with your family will not only ensure that your wishes are fulfilled in the most tax efficient way possible, but your family can better understand their possible financial futures as well.