Imagine planning your legacy meticulously, only to find that unforeseen events and legal nuances have drastically altered your intended outcomes.
This scenario isn't just a hypothetical; it's a reality that many families face.
Understanding the common pitfalls in inheritance tax planning is crucial for ensuring your assets are distributed according to your wishes while minimising tax liabilities.
Solid financial planning is essential to managing inheritance tax.
People often make several mistakes with their tax planning. Here are three major mistakes we’ve seen individuals often make in their inheritance tax planning.
1. Failing to Regularly Update the Will
Life is dynamic, and significant changes such as marriage, divorce, or the birth of children necessitate updates to your Will. Neglecting to revise your Will can lead to unintended consequences.
What happens when you die without an up to date Will?
As an Independent Financial Advice firm, we often hear a lot of horror stories from when things have gone wrong.
Mark created a Will after the birth of his second child, Richard, leaving everything to his wife, Jennifer, or if she predeceased him, to his children. After a divorce and a subsequent remarriage to Elizabeth, Mark failed to update his Will.
Consequently, when he passed away, his estate fell under intestacy rules, leading to a distribution that was far from his wishes.
The rules of redistribution when somebody dies Intestate can be complex, and ultimately, not having a valid will means that you have no control over the distribution of your estate and therefore cannot plan for inheritance tax.
Key Lessons:
Regular Updates: Ensure your Will reflects your current family and financial situation.
Contemplation of Marriage Clauses: If drafting a Will before remarriage, include clauses that anticipate the marriage to keep the Will valid.
Age Conditions: Consider setting up trusts to manage the assets for children until they reach a certain age.
2. Not Considering Trusts for Tax Efficiency
Transferring assets into Trusts is a smart way to manage your inheritance tax liability. Trusts can provide control over asset distribution, protect assets from claims, and offer tax benefits.
Two primary types of transfers are relevant here: Potentially Exempt Transfers (PETs) and Chargeable Lifetime Transfers (CLTs).
Trust Planning for Inheritance Tax
Potentially Exempt Transfers (PETs): Gifts made during a person’s lifetime. If the person survives for seven years after making the gift, it becomes exempt from IHT. During that 7 year period post-transfer, the amount of IHT due diminishes each year.
Chargeable Lifetime Transfers (CLTs): Transfers into certain types of trusts, such as discretionary trusts, are subject to immediate IHT at a reduced rate of 20%.
Benefits of Trusts:
Control: Dictate how and when beneficiaries receive their inheritance.
Tax Efficiency: Reduce the IHT burden on your estate.
Protection: Safeguard assets from potential claims or mismanagement.
Example Trust Strategy
Mark could have set up a trust to manage his home and other assets, ensuring Elizabeth had a right of occupation while ultimately preserving the assets for his children. This could also provide tax benefits and protection against future contingencies.
Loan trusts are another option for individuals with more liquid capital in their estate that need a more sophisticated approach to IHT planning. This allows investors to loan capital to the trust – and whilst the loan value remains part of the settlor’s estate for IHT – any growth on the capital when invested in an offshore bond does not form part of the estate. Your financial adviser can talk to you about this arrangement, along with any relevant risk warnings.
3. Ignoring the Implications of Intestacy
When someone dies without a valid Will, their estate is distributed according to the rules of intestacy, which may not align with their wishes and is very hard to plan around. This can lead to significant financial and emotional repercussions for the surviving family members.
Understanding Intestacy
Distribution Rules: Under the intestacy rules, spouses, children, and other relatives inherit in a predefined order.
Statutory Legacy: Spouses receive a statutory legacy plus a portion of the remainder, potentially leaving children with less than intended.
Case Study: The Consequences of Intestacy
In Mark's case, intestacy rules resulted in Elizabeth receiving the majority of his estate, with his children receiving significantly less.
If Elizabeth were to unexpectedly die, her estate - including assets from Mark – would pass to her mother under intestacy rules, leaving Mark’s children with nothing from Elizabeth’s inheritance.
Preventing Intestacy Issues
Regularly Update Your Will: Reflect life changes such as marriage, divorce, and the birth of children.
Include Clear Provisions: Ensure your Will specifies the distribution of your estate to avoid intestacy.
Use Legal Tools: Utilise intestacy calculators and legal advice to understand potential outcomes and take proactive measures.
Does your inheritance tax plan work for you?
Effective inheritance tax planning requires regular updates to your Will, strategic use of trusts, and a thorough understanding of intestacy rules.
By avoiding common pitfalls, families can navigate the complexities of inheritance tax and ensure their estate is distributed according to their wishes. Proper estate planning not only preserves wealth but also provides peace of mind for both the individual and their loved ones.
At BlackBear Financial Group, we’re able to support you with all matters surrounding IHT and Estate Planning. Get in touch today if you’re looking for an Independent Financial Adviser that you can trust.
Please note that the FCA does not regulate tax and trust planning.
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