by Lisa De Silva
Understanding the law surrounding the three key issues of pensions, inheritance tax and will making can be tricky at best. Here, Lisa de Silva puts it into simple, jargon free terms.
The UK legal system has evolved over hundreds of years to keep pace with our ever-changing society, to ensure that it remains as civilised, fair and protective of citizens as possible. As such, it is one of the most important institutions in the land. But how well do you know your legal rights when it comes to long-term financial planning?
Long-term financial planning is important in maintaining a good quality of life and the earlier you start the better. To help you understand how legal issues can impact financial planning, both positively and negatively, we’ve taken a closer look at the law around pensions, inheritance tax and will making. Hopefully, some of the issues raised will help set you on the road to creating and maintaining a quality lifestyle for you and your heirs, but we would strongly advise you seek the professional services of a solicitor or accountant to advise you on your individual circumstances.
How The Law Has Recently Changed Around Pensions
The issue of pensions is a vast and complex area, so we have chosen to focus on how the law has recently changed to affect pensions.
Automatic Enrolment Schemes
In April 2017, it became a legal requirement for employers to enrol staff in a workplace pension under the automatic enrolment scheme. All employees are eligible for automatic enrolment as long as they meet the following criteria:
- they are not already in a workplace pension
- they are aged 22 years or older
- they are under State Pension age
- they earn more than £10,000 p.a.
- they work in the UK
Employees can opt out, but as employers have to contribute to the scheme as well as the employee, it is a good idea to join. What’s more, employees get tax relief on their contributions to the scheme.
‘Pensions Flexibility’ Rules
The law has also changed since April 2015, when new ‘pensions flexibility’ rules were introduced to allow people over the age of 55 years to access as much of their savings from a defined contributions pension scheme as they wish, with 25% of the sum being tax-free.
The money can then be used in three main ways:
- to buy a lifetime annuity but with the option to take a tax free lump sum of up to 25% of your pension pot
- to put the funds into drawdown with no limit on the amount you can take each year, again you can take a tax free lump sum of up to 25% of the pot at the same time
- to take the money as a lump sum payment, with 25% being tax free. This is called an ‘uncrystallised funds pension lump sum’ (UFPLS)
Planning For Inheritance Tax
Inheritance tax (IHT) is a tax levied on the property and assets you have at the time of death and anything you have given away during the previous seven years. Generally, there is no IHT to pay if the total estate is valued below £325,000, or you leave everything to a spouse, civil partner, charity or community amateur sports club.
The standard level of IHT is 40% and it is only charged on the part of your estate that is above the tax threshold. For example, if an estate is worth £500,000, the 40% tax will be due on £175,000 (£500,000 minus £325,000).
The assets that make up an estate include any property and its contents, vehicles, shares/investments, banks/building society accounts, foreign property, jewellery and anything given away seven years before your death. It is the job of your executor(s) to value the estate, send the valuation to HMRC and then pay any tax owed. The estate’s value needs to be reported to HMRC even if it is under the £325,000 threshold.
In recent years the law has change around IHT to include Transferable Main Residence Allowance (TMRA) to help people pass property onto descendants. This means that if you leave your home to your children or grandchildren, the tax threshold increases to £450,000. For married couples and those in a civil partnership, the unused threshold can be added to your partner’s threshold giving a total estate value of £900,000 before any IHT is due. This figure is set to rise to £500,000 for individuals and £1 million for couples by 2021.
How To Reduce Inheritance Tax
Early planning is key to minimising the amount of IHT payable. Firstly, do ensure you have made a will to protect your decisions on how your assets are distributed after your death and to ensure that your affairs are dealt with tax efficiently. One way to reduce the tax is to reduce the value of your estate before you die. However, do be aware that any money or property given away will be liable for IHT if you die within seven years and it is strongly recommended that you invest in professional legal advice before embarking on this course of action as this is a complicated area.
The main ways to help reduce IHT include the following:
- give up to £3,000 away each year and pay no tax
- if unused this tax-exempt allowance can be carried over to the following year to £6,000
- gifts of up to £250 a year to any one recipient are excluded from IHT, so this small amount can be given annually to a large number of relatives
- give a wedding gift up to £5,000 to a child and £2,500 to a grandchild tax-free. As the allowance is per person, couples can give up to £10,000
- downsize your home and spend the capital
- leave 10% of your estate to charity and under Legacy10 legislation, the level of IHT on the rest of your estate reduces to 36%
- set up a Discretionary Trust which could help to reduce the rate of IHT
- put money into specialist tax-efficient investments, loan and bonds plans and flexible revisionary interest trusts
- use a ‘gift inter-vivos’ or whole life assurance policy to generate the money to pay for IHT
- a trading business can be wholly or partially exempt from IHT
- agricultural land that is let out or farmed can be exempt from IHT
- if death was caused by an injury or wound sustained from active service against a state enemy exemption can apply
The Importance of making a Will
It is important to make a will to ensure that your estate is distributed in accordance with your wishes after your death. A will gives you the opportunity to specify which family members, friends and charities receive your assets. It is particularly important for those with children under 18 years to make a will in order to name those they wish to become legal guardians in the event of both parents’ deaths. You can also use a will to give instructions about your funeral. Once you have written a will do make sure family members know where it is kept, or any details of a solicitor it is lodged with.
If you die with no will, or your will is deemed to be legally invalid, your estate is divided up under the rules of intestacy. Under the rules of intestacy only married, civil partners or other close relatives can inherit. So, making a will is vital for unmarried couples as if one dies intestate, it will cause serious problems for the remaining partner.
Upon death, the executor(s) of the will makes a valuation of the estate that is submitted to HMRC. They can then apply to the Probate Registry for a Grant of Probate. Once any inheritance tax has been paid and an oath has been sworn in court, the Grant of Probate is given which allows the executor(s) to close accounts, transfer assets, deal with property and pay any debts. All debts must be settled before the assets are distributed. This process can be completed by a solicitor if required.
As this is just a snapshot of the impact the law can have over your long term financial planning, we would strongly recommend you take professional advice from a solicitor or accountant to ensure your individual circumstances are accounted for.