No one likes paying tax, but inheritance tax is probably the most unpopular tax of all. This is because inheritance tax is perceived as being a tax on the dead rather than the living. It is also a tax on giving rather than receiving. To rub salt into the wound, inheritance tax is a tax on wealth that has already been subject to a lifetime of tax.
Inheritance tax is perceived as being unfair
This perception has made the avoidance of inheritance tax an obsession for some. So much so, that in many cases, people sacrifice their lifestyles today to reduce the inheritance tax liability for their beneficiaries. But is this right? Wealth should be enjoyed, not gifted away to avoid tax, some would say!
With the home being most people’s most-valuable asset, one of the most common questions we get asked as financial advisers is: “What can I do with my house to reduce inheritance tax?”
Gifting your home
This is certainly one way of avoiding inheritance tax. However, you could be in for problems if you continued to live there. Making such a gift would mean that your home no longer belonged to you. So, you’d have to pay rent at market rates to the new owners for the entire gift to be considered valid by HMRC. Many people find this off putting.
Putting your home into a property trust would work in much the same way. Like gifting your home, you’d have to pay the trustees a market rent for the trust to be considered valid by HMRC. This is quite a specialist area, so expect to pay hefty solicitors fees. Th trust would need to be registered and updated periodically. In both cases, the idea would be for the property to fall out of your estate after 7 years.
You can learn more about inheritance tax at the government website below.
Could I use life insurance to pay the inheritance tax bill?
In a word, yes. The first thing to do would be to work out the inheritance tax bill you’d expect your heirs to pay. Because this may be a moving target (typically upward) it may be prudent to consider a policy that increased at a steady rate or in line with inflation.
The policy itself would be a whole of life policy which would pay out on “second death” if you were married and had joint assets. It would have to be written in trust to avoid it being added to the value of your estate, thereby compounding the problem. It would be worth working with a qualified financial adviser to discuss your options.
Could releasing equity from my home reduce my inheritance tax bill?
Equity release allows you to take cash out of your home if you’re aged 55 or over without having to move. It is a long-term loan which is eventually repaid on the sale of your home when you die or go into long term care. Interest would accrue over the term of the loan – compound interest, if you opted for no repayments.
Turning an illiquid asset into liquid funds would give you more planning options regarding the released capital. You could spend it, thereby reducing the value of your estate and potential inheritance tax bill, or gift some or all of it to beneficiaries. Using the released capital to fix up your home would increase its value and prove counterproductive.
It certainly makes good financial sense to take steps to avoid a large inheritance tax bill for the heirs to your estate. We however don’t believe you should sacrifice your standard of living to do so. Equity release allows you to enjoy your otherwise tied-up wealth whilst reducing the value of your taxable estate. The best of both worlds? Perhaps. After a lifetime of hard work, why not?