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If you’re part of an extended family and want to provide for everyone satisfactorily on your death, you will need to plan carefully.
Making a Will is essential
If you have children, you’ll probably want them to inherit your estate when you die, or when your spouse or civil partner dies. You may also want your step-children to inherit.
Under the revised rules on intestacy that were introduced in 2014, the estate of anyone who dies without a Will who is in a marriage or civil partnership where there are no children, passes entirely to the surviving spouse or civil partner, and other relatives will receive nothing.
If the spouse or civil partner dies without a Will and there are children of that relationship, a surviving spouse or civil partner will receive £250,000, and half of the balance absolutely with the rest being held in trust until the children are 18, when it will be divided equally between them.
This means that parents, brother, sisters, nieces and nephews may inherit under the rules, but it will depend on whether there are closer surviving relatives or a spouse still living, and on the value of your estate.
Not only does making a Will give you the opportunity to make sure that the members of your extended family are taken care of in the way in which you would have wished, it also gives you the opportunity to manage your Inheritance Tax (IHT) liability.
Inheritance Tax considerations
April 2017 sees the introduction of the new ‘family home allowance’ or residential nil-rate band available to those leaving their main residence to their direct descendants (children, step-children or grandchildren). This new rate band will apply if you want to pass your main residence to a direct descendant, like a child or grandchild. It’s important to note that only direct descendants can benefit, and that doesn’t include nieces and nephews for example. So not everyone will be able to rely on it for IHT planning purposes.
The allowance is being introduced in stages over 4 years, with a limit of £100,000 from April 2017, rising to £175,000 per person in 2020. This is in addition to the individual allowance for IHT which remains unchanged at £325,000.
Once the changes are fully implemented, they will mean that each parent will be able to leave £500,000 in assets that include a ‘family home’ component of at least £175,000. As this allowance can be passed from one partner to another on death, when the first partner dies their allowance can be transferred to the surviving partner meaning that they will then have an allowance of £1 million.
Where a property is worth over £2 million, the family home allowance (but not the individual allowance of £325,000) reduces by £1 for every £2 of value above £2 million. With property values remaining high, many more families are likely to find themselves caught in the IHT net.
Setting up a trust
One of the ways of managing a IHT liability in a blended family situation is the use of a life interest trust. This provides for your surviving spouse during their lifetime, with the assets then passing on to your children or other beneficiaries chosen by you.
The 7-year rule
To reduce the amount of IHT payable, many families consider giving their assets away during their lifetime. These are called ‘potentially exempt transfers’. The catch is that for these gifts not to be counted as part of your estate on your death, you must outlive the gift by 7 years. If you die within 7 years and the gifts are worth more than the nil rate band, taper relief applies so that if you die say within 6 years the tax will be less than if you were to die a year after making the gift.
Gifts must be outright, and you can no longer benefit from them. So, if you were to gift your home, but continue to reside there, HMRC would consider this to be a ‘gift with reservation’ and include the value as part of your estate.
Using your annual allowances
Each financial year you can make gifts of up £3,000 (in total, not per recipient) and if you don’t use this in one tax year, you can carry it over to the next year, which means you could give away £6,000.
Gifts of £250 to any number of people are exempt. Each parent of a bride or groom can give up to £5,000; grandparents or other relatives can give up to £2,500 and any well-wisher can give £1,000. Gifts to registered charities and political parties are also exempt.
There is another way of passing money to the next generation which allows for gifts to be made from surplus income. Conditions apply, and advice would be needed to ensure that the gifts are made in the correct way.
Every family’s circumstances are different, so taking bespoke professional advice is essential in planning your estate.