Inheritance tax explained by Interactive Investor expert
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Reducing your exposure to inheritance tax is important than ever, as Chancellor Rishi Sunak has frozen IHT thresholds for five years. This means rising share and house prices will drag more unsuspecting families into the net.
Inheritance tax is a complicated subject, and without independent financial advice it is easy to make costly mistakes.
As an independent financial adviser himself, Tom Skinner knows the importance of IHT planning.
Tom, 39, who is co-founder of London-based Barnaby Cecil Financial Planning, also knows the importance of protecting his family should the worst happen.
He and wife Jane have taken out life insurance policies worth £1.5 million each, for their two young boys Charlie, 5, and Otto, 3. They’re worth £3 million in total.
However, Tom said that raises an issue that many ordinary people overlook.
If someone receives a life insurance payout, the payout will be added to the value of their other assets, including property, shares, Isas and so on, when calculating total value of their estate.
It could push many past the IHT nil-rate threshold unexpectedly, so they incur the 40 percent death charge.
If that happens, it could mean a big chunk of their total wealth goes straight to HM Revenue & Customs, rather than those they love.
According to Tom: “It can be very distressing for a family to learn that 40 percent of an insurance policy is lost due to the cash being paid directly to the estate.”
Even if your life insurance policy is worth less than £325,000, it could push you into the danger zone.
Tom said many don’t realise the danger because they will not have taken independent financial advice at any point.
One in four estates that are hit by an IHT bill each year include money from life insurance policies, HMRC figures show, so it’s a major problem.
In total, these families may have paid more than £280 million unnecessarily, in the 2018/19 tax year alone.
Given that around 22,000 estates pay inheritance tax each year, that means more than 6,000 families could be throwing money away every year.
However, Tom said you can get around this by filling a simple form. “If you write a life policy into trust, it will not normally form part of your estate on death and would therefore not be liable for inheritance tax.”
Insurance companies will typically send out a trust form when you take out a life policy, but many people fail to fill it in.
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Tom said: “If you have life insurance and it isn’t in trust, phone your provider and ask for a trust form.”
Gifts and money paid into trust are free of IHT, provided you live for another seven years after making them.
So it pays to plan in advance while you are relatively young and in good health, Tom said. “If you are seriously ill and die within seven years of setting up the trust, its value may still be included in your estate and charged IHT.”
Putting life insurance inside a trust also means your family shouldn’t have to wait for probate either, Tom added. “This speeds up payments and could help dependants who need the money to cover day to day bills.”
Only six percent of policies are written in trust, according to insurer Aegon, so check your position now.
Tom Skinner’s family is protected from both death and taxes. Is yours?
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