The Two Certainties In Life: Death & Taxes.
An introduction to Inheritance Tax for doctors

Hello, this is Gemma at Clinic Alchemy, the Alchemist to give you great tips on how to manage and grow your wealth. 

Today I’m going to give you an introduction to inheritance tax (IHT) and work through an example to see how IHT is calculated. The example can be put to good use; you can apply the calculation to your estate to see if you or your family will be affected by inheritance tax. If the answer is yes then jump on to the second blog where I will explain several strategies that you can use to minimize the bill, whilst maximizing the estate that can be passed onto your loved ones, not HMRC! (Actually some of these strategies may even help your private practice profit…)!! 

Quick stats to get us started: 

Did you know that; 

  • Receipts from HRMC are set to be around £6.2 billion by 2020  
  • Inheritance tax is affecting more and more estates each year 
  • In 2015/16 IHT receipts to HMRC increased by 22% 
  • IHT needs to be paid within 6 months of death  
  • IHT needs to be paid before non-property assets can be passed on to the beneficiaries 

Shocked? Yes, most people are when I tell them! So today Doctors and Surgeons I’m going to give you an in-depth introduction to a very taxing issue, Inheritance Tax. 

What exactly is Inheritance Tax (IHT)?  

IHT is the tax on the estate that an individual leaves behind when they pass away, and on certain lifetime gifts. An estate includes any property, money or other assets once any debts, such as a mortgage, have been paid off. 

What about the nil rate band (NRB)?  

A certain amount of your estate can be passed on tax-free, which is known as the ‘nil rate band’. Currently, the nil rate band is £325,000 per person, which is frozen until 2021. Anything above this nil rate band is subject to 40% IHT (or 36% if the deceased leaves 10% or more of their net estate to charity).  

How about the £1m nil rate band? (I think you are referring to the Residence Nil Rate Band (RNRB)) 

In April 2017, the government introduced an additional allowance known as the RNRB. It applies to the main home that is transferred to direct descendants (such as children or grandchildren). This allowance started at £100,000 per person and is increasing by £25,000 each year to reach £175,000 per person in 20/21. This will effectively raise the IHT-free allowance to £500,000 per person in 2021 

However, estates worth more than £2 million will be subject to a taper; for every £2 above £2 million, the RNRB will be reduced by £1. This means that in 20/21 joint estates worth £2.7 million and over will not benefit from the RNRB.  

How about if I am married?  

Any part of an estate that is left to a spouse or civil partner is exempt from IHT, as long as they permanently reside in the UK and you were still living together at the time of death. When a spouse or civil partner passes away, any unused portion of their IHT-free allowance can be claimed when their surviving spouse / civil partner dies, meaning that on second death they can double their nil rate band to £650,000.  

If you include the Residence Nil Rate Band, this will be equivalent to a total IHT exemption in 2021 of up to £1,000,000 for the remaining civil partner or spouse that jointly own a family home and want to pass it on to their children or other direct descendants.   

So, will I get a £1m tax free threshold? 

Hmm you may be one of a few that do, most people’s estate however are over £2m and so they won’t qualify for the full residence nil rate band. Sorry! (It was a great campaign pull preelection though…)! 

Actually, the stats show that a mere 0.04% of the population will benefit from new residence nil rate band.  

Ok so what will the tax bill be on my death? 

To help you understand how IHT is applied to an estate, here is a worked example based on the IHT liability of a single person who isn’t eligible to use the residence nil rate band:  

* Hang on what is my estate for IHT purposes? 

Your estate is the sum of everything you own, or the share of anything jointly owned (including property, savings and investments), and large gifts made in the last 7 years, minus any outstanding debts, anything left to charity and the reasonable costs of a funeral. In most cases it won’t include your pension, it will include life insurance policies unless this has been placed in trust. It may include your business, and this depends on whether the business is trading and the amount of cash in the business… (Important point I will explain in further detail in the next blog). 

How much IHT will your estate pay?  

So for an individual with an estate of £1m, £270,000 needs to be given to HMRC…..  

Your IHT liability is usually paid from your estate, after all debts have been settled, and is normally payable within six months from the end of the month in which the death occurs (after this time, interest is charged on the unpaid amount). So yes, the executors of this persons estate will need to obtain £270,000 before assets can be distributed…… 

How about if I am married? 

If you are married or in a civil partnership: you can pass any of your estate onto your spouse or civil partner IHT-free. The value of your estate over £325,000 which is passed on to anyone other than your spouse or civil partner is subject to up to 40% IHT 

If you are widowed: if your spouse or civil partner passed on an estate worth more than the nil rate band at the time of their death to anyone other than you when they died, you will not benefit from their nil rate band. Up to 40% IHT will be due on the value of your estate over £325,000 when you die  

If your spouse or civil partner left you everything and did not make any gifts during their lifetime, you can combine their nil rate band with yours, meaning that up to 40% IHT would be due on the value of your estate over £650,000*.  

*The Residence Nil Rate Band may apply where the main home is being passed to direct descendants.  

What will the tax bill be on a married couple? 

Let’s work though an example: 

In 2016, the wife passed away and her husband inherits her entire estate. The wife did not make any large gifts in the 7 years prior to her death. A year later the husband passes away leaving an estate worth £2.8m to his children 

There is no IHT due on the wife’s death as she passed her entire estate to her husband. On the husband’s death the executors can claim the wife’s nil rate band. So in total £650,000 of the estate will not be subject to inheritance tax. Everything above this will be taxed at 40%, as calculated below: 

Yes, that’s correct on an estate of £2.8m, £860,000 will go to HRMC. 

Fine, I will just give it away! 

Well then I will just give my estate away just before I die… sorry no this doesn’t work. Any outright gifts made in the last 7 will be retrospectively part of your estate for inheritance tax purposes. These are known as a potentially exempt transfer.  (PET)  

If you die within 7 years, the gift will eat away the NRB first. Once the NRB has been used up the gifts will then be taxed on a sliding scale, known as taper relief.  

Next steps ACT 

As said, there are two certainties in life – death and taxes – and these are the very two things that no one likes to talk about. Yet, to avoid these two topics can mean a significant tax bill for your loved ones when they inherit from you. 

Personally, I think Inheritance tax is a voluntary tax that you can plan for so why pay more than you have to. It is painful to think that almost half of your hardearned wealth, on which you’ve already paid taxes, will go to the taxman rather than your loved ones. On top of that, inheritance tax needs to be paid before your loved ones can receive the non-property assets. It may mean that your loved ones will need to sell the family home to pay the tax bill, but this can easily be avoided with a little planning. To be honest with no planning it can be a bit of a mess. 

We know how easy it is to shy away from planning for inheritance tax. You may fear that it will mean a loss of financial control or that you won’t have enough to live on. Often, it is simply something that you may not want to think about it. Just talking about inheritance can, for some people, be difficult and sensitive – not really an ‘appropriate’ subject to bring up during Sunday lunch!  

Instead of avoiding the topic, it really is worth having a conversation with your loved ones about it. How you do this will depend on the dynamics of your family but, at some point, it is good to get everyone together to ensure that your children/loved ones are clear about the assets and how they are to be divided. 

Leaving it too late potentially means a huge tax bill on the horizon with very few options to reduce it. What commonly happens is that people only start to think about inheritance when they have moved into a care home. At which point the strategies available are limited and at times high risk.  

So, act now. If you have an estate liable for inheritance tax, then the sooner you start to plan, the better. In my next article I will explain the tools of the trade to ensure that your assets go where you want them to go, mitigating inheritance tax while preserving your net wealth and cash flow.  

Give yourself peace of mind and clarity for the future by acting today. If you need help with your Inheritance Tax planning or investment concerns, feel free to get in touch at Gemma@clinic-alchemy.com 

 

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By |2019-09-17T11:20:19+01:00September 17th, 2019|Financial Planning, Planning, Retirement, Tax|0 Comments

About the Author:

I’m a fellow, chartered financial planner whom specialises in advising on pensions, investments, and tax efficient planning to business owners, medical professionals, entrepreneurs and retirees. My goal is to help clients achieve their financial goals and aspirations, now and in the future. Through careful, smart, savvy planning, I will guide you through the complex maze of rules and investments and help you plan effectively for your future; investing in a clear, understandable, safe and controlled manner to ensure that ultimately, you achieve your financial plans and are not hit by an unexpected tax bill.

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