As well as being April Fool’s Day, this year 1 April is also National DIY Day in the UK.
Taking place on the first Saturday of April each year, it recognises that the onset of spring is often the time when many people are tempted to start DIY projects around the house.
Often, this can result in a considerable cost saving, especially if you are practical and are prepared to put in the work and commitment required.
But when it comes to planning your financial future, doing it yourself, while well-meaning, can be perilous and potentially very expensive.
In my experience, one area where people are inclined to adopt a DIY approach is estate planning. However, it’s easy to end up unwittingly falling foul of tax legislation and having your loved ones face an unwelcome demand from HMRC.
Not only that, but a mistake in one tax year can have a knock-on effect into the future. You may not even realise you’ve made an error in your lifetime, and it may be left to your beneficiaries to pick up the bill.
Read about why expert advice is so important, and two of the common – and costly – mistakes many people make when it comes to DIY Inheritance Tax (IHT) planning.
Your Inheritance Tax liability could be substantial
The current IHT rate is 40%. This is charged on the total value of your estate that’s above the threshold, known as the nil-rate band (NRB), which is currently £325,000.
On top of that, if you own your home, your threshold can increase to £500,000 if you leave it to your children or grandchildren, and the overall value of your estate is worth less than £2 million.
Additionally, if the threshold has not been fully used when the first person in a marriage or civil partnership dies, you can transfer the unused part to your surviving spouse or civil partner.
Given these figures, it’s easy to see that, if you have substantial assets, your IHT liability on your death could be high. You could leave your beneficiaries with an unwelcome tax bill.
Bearing this in mind, it makes sense to take steps to try and reduce that liability while you’re alive.
A common way to reduce your IHT liability is to gift assets
You can potentially reduce the amount of IHT payable when you pass away by gifting some of your assets while you are still alive.
As a rule of thumb, your beneficiaries will not pay IHT on the value of anything you gift to them if you live for seven years after the date of making the gift.
However, there are some gift exemptions where no IHT will be payable, regardless of how long you live. These include gifting a total of £3,000 each year to one or more beneficiaries, where this amount will immediately fall outside the value of your estate.
Additionally, you can make exempt gifts for weddings or civil ceremonies, and payments towards the living costs of elderly relatives.
You can also make individual gifts of up to £250 to anyone who has not benefited from any other of your exemptions during the year.
Find out more: How to gift your assets to reduce your Inheritance Tax liability
Gifting assets through the use of trusts
Another highly tax-efficient way to reduce the IHT liability on your estate is through trusts.
Using a trust means you effectively pass control of certain assets to trustees, meaning they sit outside the value of your estate for IHT purposes.
When you’re setting up the trust, you can state how the trustees should manage the assets in question. This can be particularly helpful if you’re looking to pass assets on to your children or grandchildren.
There are a variety of trust options, and we would strongly recommend that you seek expert advice to ensure you set up the most appropriate trust relating to your specific circumstances and needs.
Find out more: 3 common trusts used in Inheritance Tax planning
Your domicile is important when it comes to Inheritance Tax liability
If you are not domiciled in the UK, the value of your estate that will be liable to IHT on your death will generally be limited to the value of your assets in the UK.
This is particularly true when it comes to UK residential property. A common misconception is that a UK property is exempt from IHT if it’s owned and managed through an offshore company.
This is not the case, and making this assumption has proved costly to many people.
The whole issue of IHT and domicile can be complicated, and we would recommend that you read our guide on this subject.
Find out more: UK Inheritance Tax – 9 key points for non-UK individuals
There are 2 common DIY Inheritance Tax pitfalls
I’ve helped many Charlton House clients plan their estates.
Often, this has involved unwinding unsuitable arrangements that they have made in all innocence, believing them to be effective IHT mitigants.
Two of the most common relate to residential property.
Pitfall 1: Gift with reservation of benefits
As you’ve already read, gifting assets is a common way to reduce your IHT liability.
However, gifting your main residence to your children and then retaining a benefit in it (such as living there rent-free) counts as a gift with reservation of benefit (GROB), meaning that, on your death, the value of the property will be treated as part of your estate for IHT purposes.
Likewise, if you decide to fund the purchase of a property and put it in joint names with your children, there will be a gift with a reservation of benefit on the child’s half-share. This will mean the whole property will form part of your estate for IHT purposes on death.
It’s possible to avoid a GROB scenario in these circumstances by paying a market rent to your children if you’re living in the property.
However, it’s the type of arrangement that will be looked at very closely by HMRC, as they are aware it’s often exploited to avoid IHT.
It’s also worth being aware that, even if you are paying a market rent and the arrangement is correctly set up and above board, the value of the property is not automatically excluded by the payment of rent, as the aforementioned seven-year rule applies.
Also remember that such a gift made to your non-dom spouse will not work. The spousal exemption to non-dom spouses is limited to £325,000. In addition, you may have your respective NRB of £325,000.
However if you live with your non-dom spouse in the property that is acquired either directly or indirectly through your gift, then GROB will still apply and the planning will fail.
Pitfall 2: Pre-owned asset tax
As well as gifting your property to your children, another common DIY IHT pitfall that I’ve come across on more than one occasion is the situation that occurs if you gift money to your children with the intention that they use this to purchase property.
In this scenario, you will be deemed to have pre-owned the property in question. As a result, you may fall foul of pre-owned asset tax (POAT) legislation that was introduced in April 2005 with the expressed intention of clamping down on such attempts at IHT avoidance.
You will likely be subject to an Income Tax charge that will apply all the time you have the ability to use the property for your own residential purposes.
What’s more, POAT can be applied retrospectively, going back to March 1986, and applies not only to residential property, but also to other tangible assets.
Some of the instances I’ve come across have involved a non-dom who has never actually lived in the UK planning to move there, being aware of IHT issues, and trying to reduce their future liability by buying residential property for their children outright.
Arrangements such as this can be complicated, and potentially very expensive to unwind. Again, we would strongly recommend that you seek advice from an expert.
Estate planning advice is important
As you can probably appreciate, IHT regulations can be complex. If you are not aware of the specifics, you could find yourself in a difficult situation during your lifetime.
We would always recommend that you seek expert advice when it comes to your estate plan. DIY IHT arrangements can often appear to be effective at the outset but can lead to serious financial problems at a later date.
Get in touch
If you’d like to discuss your own estate plan, please get in touch.
You can contact us by email or, if you prefer to speak to us, you can reach us in the UK on +44 (0) 208 0044900 or in Hong Kong on +852 39039004.