Over the course of your life you will accumulate assets and wealth, all of which will hopefully culminate in a comfortable retirement and a financial legacy you can leave for the next generation.

What you need to be careful of is your growing wealth resulting in an Inheritance Tax trap for your loved ones. Rising property prices and an increase in ‘blended’ families could mean Inheritance Tax affects a greater number of people.

Inheritance Tax is imposed by the Government on estates valued over £325,000. The current rate of inheritance tax is 40%, meaning your beneficiaries could lose close to half of their inheritance over the nil rate band of £325,000 to the Government. This is a growing concern, as assets you accumulate that grow in value such as property and investments may mean you exceed the £325,000 Inheritance Tax allowance . Only in certain circumstances would you potentially be exempt from inheritance tax, such as if you were to leave everything above the threshold to your spouse or civil partner. Some people will also choose to leave everything above the threshold to an exempt beneficiary such as a charity.

Rising property values could trap you.

The UK HM Revenue & Customs took over £6 billion from Inheritance Tax in the last tax year based on the chart from Statista in the reference below, which is a new record at the time of data collection. This data was published in July 2023. This is a sign that more and more estates are being affected by Inheritance Tax, over the £325,000.00 tax free threshold.

Consider what we’ve seen in the property market over the past decade, if you’ve owned property over the last 10+ years you’ll be aware how much property valuations have grown and how easy it could be to have an total estate that will put you over the £325,000 Inheritance Tax allowance.

However, what can help to mitigate the property problem to some extent, is the residence nil rate band.

This is an additional allowance that individuals may be entitled to if they leave their main residence to a child or closely related person. In the current tax year this additional rate is £175,000 per individual. This in essence could mean that individuals who qualify for the residence nil rate band have up to £500,000 in nil rate bands each for inheritance tax purposes. For couples, this could mean they are entitled to up to £1,000,000 of nil rate band cover. If you pass on your property to your spouse or civil partner then inheritance tax wont be applicable.

Could a blended family affect your wealth?

Another factor in the growing Inheritance Tax trap is the increase in blended families.

A blended family, sometimes referred to as step-families, could consist of a couple with their own children, but with children from previous relationships to consider too.

Divorce and re-marriage can result in varying mixes of blended families. If your Will hasn’t been updated since remarrying, having children, or becoming a step-parent, then there’s a risk that your financial legacy may not be as you wished.

For example, combining estates when you marry a new partner could mean you go beyond the Inheritance Tax threshold. There’s then potential complications of children and step-children, how is your estate to be divided?

Think about a situation where you’ve divorced and remarried, you want to leave your wealth to your new spouse, but what about your previous partner or children from that relationship?

These are important financial decisions that will be unique to you, potentially affecting Inheritance Tax for your beneficiaries and how your estate is divided. With that in mind, it is important to seek out financial advice. A financial adviser will be able to assess your circumstances and advise you appropriately. It is also important to regularly update your will, and keep in mind that remarrying revokes any previous will.

Your Pension isn’t liable to Inheritance Tax.

A potentially tax efficient way to mitigate Inheritance Tax liability for your beneficiaries is to keep money invested in your Pension, dependent on the scheme rules of the Pension.

For example, a Defined Contribution Pension can be passed on to your named beneficiaries free from Inheritance Tax. Your beneficiaries would pay tax at their marginal rate depending on the age you pass away. For example, if you passed away over the age of 75 anyone who inherits your pension will be taxed on any income received as earnings at their marginal rate of Income Tax. If your beneficiaries take money out through pension drawdown then they will only be taxed on any income they take, in the tax year that they take it. There are no lifetime allowance tests carried out if you die after age 75. If you pass away before the age of 75, anyone who inherits your defined contribution Pension fund won’t pay any tax, subject to money being paid or transferred to another arrangement within two years from the earliest of:

• The Date the pension scheme administrator first knew of your death, or
• He date the scheme administrator could reasonably have been expected to know of your death.

With this in mind, keeping money invested in your Pension could make sense if you have concerns over the size of your estate. If your total estate are of considerable value then you’ll want to ensure you aren’t falling into an Inheritance Tax trap by neglecting to use your full Pension allowance each tax year.

Naming Pension beneficiaries is easy, simply use your Pension’s Expression of Wish form to name the people you’d like your Pension’s trustees to consider for inheritance of your assets.

Do more with your money and consider the future of your wealth today, now is the perfect time to update your will and Pension beneficiaries, or speak with a financial adviser if you have any concerns on how Inheritance Tax may affect your legacy.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Tax is subject to an individual’s personal circumstances, and tax rules can change at any time.. The Financial Conduct Authority do not regulate, Will Writing, Tax Advice and Estate Planning. This blog is not personal financial advice.

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