6 Costly Inheritance Tax Mistakes to Avoid When Passing Your Estate On To Your Children

What is Inheritance Tax?

Of all taxes raised by HMRC, the one that seems to cause the most reaction is inheritance tax (IHT), unofficially known as ‘Britain’s most hated tax’. It’s levied on the assets of people who have died.

Inheritance tax receipts into the Treasury have almost doubled since the 2010/11 tax year, rising from £2.72 billion to £5.38 billion by 2018/19.

The Inheritance Tax Threshold

This is down to a number of factors. Inheritance tax has a ‘threshold’; if your estate (the value of most of the property you own at the date of your death) exceeds this threshold, inheritance tax may be due. The threshold is officially known as the ‘nil-rate band’.

Any part of the estate up to the nil-rate band threshold is chargeable at a rate of 0% for inheritance tax purposes. Any part of the estate that exceeds this threshold becomes chargeable on death at 40%.

However, the inheritance tax threshold has been frozen at £325,000 for some years now. This has obviously not kept up with rising house prices, which has been a big factor in dragging more and more estates over the threshold and requiring them to pay tax. The average inheritance tax bill has now reached almost £200,000.

The government has tinkered around the edges of the threshold by introducing a residence nil-rate band, which added an additional nil-rate band for those passing on their home to their direct descendants, but inheritance tax receipts have continued to rise despite this.

The Top 6 Inheritance Tax Mistakes People Make Passing On Their Wealth

Given its unpopularity, many people understandably look to avoid inheritance tax if possible.

However, it’s a complicated and confusing area and one that’s easy to get wrong, which could prove costly for either you or your heirs later on down the line.

Below are six mistakes people make when trying to cut their inheritance tax bill and how to avoid them.

1. Not Having an Updated Will

Having a will — and keeping that will updated — is essential when it comes to inheritance tax.

A properly-executed will can be vital to ensuring your estate is distributed as you wish and that no unnecessary additional inheritance tax is due.

It is widely assumed that if someone is married or in a civil partnership, their entire estate will pass to their surviving spouse or partner on their death free of inheritance tax.

Yet if you do not have a will this will not necessarily happen. If you are married, have an estate in excess of £270,000 and have children, then your children will share in part of your estate. The larger the amount they receive, the more chance there is of IHT being charged.

This is because of the rules of intestacy, which govern who can inherit when there’s no will.

Another common misconception is that the UK gives status to ‘common law’ partners, i.e. those couples living as married but who haven’t actually tied the knot. In England and Wales, no provisions exist for them to inherit anything automatically if you pass away.

Regularly review your Will…

Things change, and therefore so should your will. Your old will made years ago was made in accordance with the tax laws at the time. It was also made with reference to your family structure and assets as they were at the time the will was made.

Things move on quite quickly, and so wills should be kept up to date. This is especially true if there’s been a recent marriage, as a second marriage, for instance, revokes an old will.

Recommended Online Will Writing Service

Drewberry has partnered with online will-writing giant Farewill to help those in England and Wales get a will in place if they don’t have one already.

You can read our review of the service they offer — and get access to an exclusive discount — here.

2. Limiting Gifts to £3,000 per Year

Every individual has a number of gift exemptions they can give away each year and have these gifts be inheritance tax-free.

One of the most ‘generous’ of these is the £3,000 in each tax year (6 April to 5 April) that you can gift to whoever they chose. You can carry over up to £3,000 in unused IHT allowance from one tax year to the next, but you must use up all of your allowance in that tax year.

This gift exemption means that many people think £3,000 is the maximum they can give away each year and have the gift be free from inheritance tax, but this isn’t strictly true.

Potentially Exempt Transfers
A Potentially Exempt Transfer (PET) enables an individual to make gifts of unlimited value where there is no immediate inheritance tax charge. It is only if you die within 7 years of the gift that there will be any IHT consequences.

Note that people you give gifts to will be charged inheritance tax if you give away more than £325,000 in the 7 years (and potentially up to 14 years) leading up to your death.

Other Gifts Free from Inheritance Tax…

  • Gifts worth less than £250
    You can give as many gifts of up to £250 to as many individuals as you want (although not to anyone who has already received a gift of your whole £3,000 annual exemption).
  • Wedding gifts
    In this case, if the gift is to be effective for inheritance tax purposes, it has to be made before, not after, the wedding and the wedding has to happen. You can give gifts up up to £5,000 to a child; up to £2,500 to a grandchild or great-grandchild; or up to £1,000 to another relative or friend.
  • Gifts to help with living costs
    Gifts to help pay the living costs of an ex-spouse, an elderly dependent or a child under 18 or in full-time education might be exempt
  • Gifts from your surplus income
    If you have enough income to maintain your usual standard of living, you can make gifts from your surplus income, e.g. regularly paying into your child’s savings account, or paying a Life Insurance premium for your spouse or civil partner. To make use of this exemption, it’s very important that you keep very good records of these gifts as the rules for this exemption are complex. For example, these gifts must be regular, so you need to be committed to keeping up with making these gifts. It’s best to speak to a legal or estate tax adviser first if you want to use this exemption.
  • Charitable gifts
    Whilst it is generally known that gifts to charities are exempt from inheritance tax, it is not common knowledge that you can also cut the inheritance tax rate on the rest of your estate from 40% to 36% if you leave at least 10% of your ‘net estate’ to a charity.

Inheritance Tax and Gifts Insurance

If you’re concerned about the inheritance tax that may be due on gifts you make during your lifetime — known as gifts inter vivos — then there is insurance you can purchase to pay out on your death to clear this liability during the 7 year window a gift may be pulled into your estate if you don’t survive the required time after making it.

Without a gifts inter vivos insurance policy, the recipient of the gift may have to pay inheritance tax even though the money could already be spent.

Perhaps if the gift were for a house purchase, for example, and the sale goes through, then it’s unlikely the recipient of the gift will have the spare capital to pay the inheritance tax bill due some years after the gift was made.

A gifts inter vivos policy will pay out on a sliding scale to match the taper relief available on a large gift above your inheritance tax threshold, sparing the recipient of the gift from having to find the cash long after they received the gift.

3. Not Writing Your Life Insurance into Trust

The biggest mistake we find on the protection side of the business is that our clients don’t realise they need to write their Life Insurance policies into trust.

We often explain the need to do so and the benefit of having a trust in place to hold the Life Insurance policy — if you don’t, the value of the payout will be added to your estate when you pass away.

This could tip you over the inheritance tax threshold fairly easily, even with a modest policy, meaning the taxman will take a bite out of the legacy you were seeking to leave your loved ones.

Rob Harvey, Head of Protection Advice at Drewberry

The most recent figures from HMRC reveal there were 4,360 estates that paid inheritance tax with a Life Insurance policy as part of the estate.

These policies were worth £444 million, netting the Treasury £177.6 million out of Life Insurance policies that were meant to go to the deceased’s loved ones.

Robert Harvey
Head of Protection Advice at Drewberry

It’s quick and simple to write Life Insurance into trust — in many cases it can be done online. If you need help with this please do not hesitate to get in touch.

4. Thinking Trusts Are Free from Inheritance Tax

A trust is a legal arrangement through which you can give assets to someone so they can look after them for the benefit of a third party.

For instance, you may put some of your cash in trust for your children with the stipulation that the managers of the trust don’t release the cash until your children reach a certain age.

It’s a common misconception that assets in trust are exempt from inheritance tax. However, you will need to survive 7 years (and potentially up to 14 years depending on previous gifts to trust) before the assets in the trust fall outside your estate.

jonathan cooper, senior paraplanner at drewberry

Trusts are complicated business. As such, it’s highly recommended that you use an experienced, professional adviser or a solicitor to help you identify the most suitable trust arrangement for your needs and ensure that the trust is properly administered.

Jonathan Cooper
Head of Paraplanning at Drewberry

For most types of trust, inheritance tax is charged at a lesser rate (20%) on assets ‘settled’ into the trust at the time the gift is settled — this is known as the lifetime rate because most gifts into trust are chargeable lifetime transfers (CLTs). There may be further inheritance tax due depending on the gap between you making the gift and your death.

There are some exceptions, such as if you continue to benefit from the assets. The way a trust is taxed depends on what sort of trust it is.

5. Gifting Your House But Remaining in Residence

With property making up the majority of many people’s estates, it’s one area people think is ripe for cutting inheritance tax.

One way they seek to mitigate an inheritance tax bill is to give their home to their children before they pass away — if you don’t own the home when you die, you don’t need to pay tax on it, right?

Well, while in theory that is the case providing you live for at least 7 years (and potentially up to 14 years if you’ve previously made gifts into certain trusts), this assumes you move out of the house entirely and retain no benefit from it, or at the very least pay your children, who’ll be your new landlords, a market rent for the property.

Otherwise, if you continue to live rent-free in the gifted property, then the HMRC will deem this to be a ‘gift with reservation of benefit’. This is because even though you have transferred the assets to your children you have not actually given up the use (the ‘benefit’) of it.

In such circumstances your estate would be treated as though the asset was still in your estate on death. In addition your children could actually be worse off if you choose this course of action as the property might rise in value and then be subject to capital gains tax when they sell it.

Can I Own My Home Jointly With My Child?

Yes, but again a word of caution.

It’s possible to gift away part of your home to your children and continue to live in the property. You will not typically have to pay rent to the new owners (your child) if both the following apply:

  • You only give away part of your property
  • The new owners also live at the property.

However, if you die within 7 years (and potentially up to 14 years) of giving away all or part of your property, your home will be treated as a gift and the 7 year rule applies.

While you may feel that you have a good relationship with your child and that living with them wouldn’t be a problem after you sign away part of your property to them, you have to think about the future.

By making them a part-owner of the property you give them certain rights, including potentially to evict you should relations sour. Another common issue is where your child has a spouse / civil partner who also lives in the property with you but they later separate and the ex-partner lays claim to part of the home in the divorce / dissolution proceedings.

Selling Your Home to Your Heirs for Less than Market Value

If gifting your property to your children may not work, what about selling it to them for less than it’s worth, a ‘peppercorn’ price?

Unfortunately, HMRC have already thought of this one and this won’t wash either.

The difference between the market value of the property and the reduced sum of money you sell it to your child for will be classed as a gift for inheritance tax purposes. If you don’t live for another 7 years after making the gift, it could be swept back into your estate and taxed.

Getting Inheritance Tax Advice

Inheritance tax is a complicated area, especially when you start to attempt to reduce a potential inheritance tax liability with measures such as trusts and Life Insurance policies. It’s one area that’s essential to get right, and one that often needs the help of an expert.

If you would like to discuss your options with one of our advisers please do not hesitate to give us a call on 02084327334 or email help@drewberry.co.uk.

Your Financial Plan: Build A Better Future

A good financial plan can help you make the right decisions when it comes to your finances. Make the right decisions today to build a more prosperous future.

Good financial planning with clear goals can increase your retirement income by as much as 53%. Old Mutual Redefining Retirement Survey

Why Speak to Us…

We started Drewberry because we were tired of being treated like a number and not getting the service we all deserve when it comes to things as important as planning our finances. Below are just a few reasons why it makes sense to let us help.

  • See your financial future
    We use sophisticated financial modelling technology to visually show you your financial future. A living financial plan where you can clearly see what you can achieve depending on the decisions you make – read more
  • Achieve the retirement you deserve
    Can afford that dream round-the-world trip? Can you help your children onto the property ladder? We’ll model your goals and build your financial plan to help you achieve them.
  • Our expertise saves you time and provides peace of mind
    Organising your pensions, investing your assets, managing risk and making the most of your tax allowances is all taken care of as part of your financial plan.
  • We’ve got bargaining power on our side
    This allows us to negotiate better rates for you than dealing with providers yourself.
  • You’ll speak to a dedicated expert from start to finish
    You will speak to a named expert with a direct telephone and email. No more automated machines and no more being sent from pillar to post – you’ll have someone to speak to who knows you.
  • Benefit from our 5-star service
    We pride ourselves on providing a 5-star service, as can be seen from our 2386 and growing independent client reviews rating us at 4.92 / 5.
  • Gain the protection of regulated advice
    You are protected. Where we provide a regulated advice service we are responsible for the decisions we help you make. Doing it yourself or going direct to a provider won’t provide this protection, so you won’t benefit from these securities.

I've had a professional relationship with Josh Martin, as an adviser, for around 5 years, now. I would fully recommend Drewberry to assist with your financial needs.

Mark Horsfield
15/07/2020
Need Inheritance Tax Advice?
Speak To Our Expert Advisers

Or call us on 0208 432 7333

Compare Top UK Insurer Quotes Logos
Contact Us
Head Office & Pensions and Investments
Millennium Bridge House
2 Lambeth Hill
London
EC4V 4GG
Personal Insurance & Accounts Payable
Telecom House
125-135 Preston Road
Brighton
BN1 6AF
Drewberry London Office MapDrewberry Brighton Office Map
Our Core Principles
  • 1You Come FirstWe are a client focused business who always aim to put you first.
  • 2We are ExpertsTo provide you with the best advice, we need to know our stuff!
  • 3We are HumanWe are real people with feelings who are here to help you.
  • 4We are ProfessionalProviding a 5-star service requires a professional approach to everything we do.
  • 5We are here to EducateWe don't believe in sales, we are here to educate so you can make informed decisions.
Finalist - Moneyfacts AwardsFinalist - Cover Excellence AwardsHighly Commended - Protection Review Awards
Proud member of AMII (Association of Medical Insurers & Intermediaries)Proud member of Money Advice ServiceProud member of UnbiasedProud member of BIBA (British Insurance Brokers' Association)
Cookie Use

Drewberry™ uses cookies to offer you the best experience online. By continuing to use our website you agree to the use of cookies. If you would like to know more about cookies and how to manage them please view our privacycookie policy.