Although the idea of discussing how you might manage a substantial inheritance is difficult, particularly if you have lost a close relative or friend, the resulting change in your financial and personal circumstances is likely to prompt a review of the options open to you.
As with any significant life event, we would recommend that the first task is to review your will and consider making lasting powers of attorney. These actions will help ensure that your wishes are carried out, should you lose mental capacity, and your assets are inherited by the people you want to benefit.
Whilst this leaflet cannot replace advice from one of our team tailored to your specific circumstances, it highlights the common tax considerations which may occur after receiving an inheritance.
Inheritance Tax (“IHT”)
On the assumption that receiving an inheritance, subject to any available allowances and reliefs, increases the value of your estate and your consequent IHT liability, you may wish to give all or part of your entitlement away to your intended beneficiaries, for example your spouse or children, or put it into a trust. This can be done via a deed of variation and, providing it is completed within two years of the date on which the person who left you the inheritance died, the gift of your entitlement could be treated for IHT and capital gains tax purposes as if it had been made from the deceased’s estate rather than by you personally.
If you did not want to gift assets directly to your intended beneficiaries immediately, setting up a trust by a deed of variation would mean that you could also receive benefit from the trust without the assets being treated as part of your estate whilst they were held in the trust.
If your receive your inheritance and then gift some or all of it to your intended beneficiaries or a trust without completing a deed of variation, then you would need to survive seven years, and you could not be a potential beneficiary of any trust, if the gift is to fall outside of your estate for IHT purposes.
Your income tax is calculated according to your annual income over and above the personal tax allowance (which is £11,000 for the 2016/17 tax year but decreases eventually to nil where a person’s gross income is between £100,001 and £122,000). If you are a basic rate tax payer, any income between £11,001 and £43,000 is taxed at 20%; for a higher rate tax payer, any income earned between £43,001 and £150,000, is taxed at 40%; and any income over £150,001 is taxed at 45%.
Income earned on your inheritance whilst it is held in the estate may push you into a higher tax band for a tax year in which the administration of the estate takes place. If this is likely, you should ask the administrator of the estate whether any cash/asset distributions from the estate could be spread over more than one tax year to avoid you having to pay at higher income tax rates.
Capital Gains Tax (“CGT”)
Selling a personal asset can attract CGT on profits made above the annual tax-free allowance, currently £11,100. It is the responsibility of the estate’s executors to establish if CGT is payable on the profits of any assets sold from the estate for more than the value at the date of death.
The annual tax-free allowance is only available to executors in the tax year of death and the following two tax years. The executors will be taxed on any gains above the available allowance at 20% or, if the asset disposed of is a residential property, 28%. Both figures are subject to any losses which can be deducted and any reliefs which may be applied.
If it is likely that any gains will exceed the tax-free allowance, there are options available to the executors of an estate. For example, assets or shares of them can be transferred to the iestate beneficiaries before a sale so that each beneficiary can use their own tax-free allowance. If a beneficiary is a basic rate tax payer and their income and net gains after deduction of their own annual tax-free allowance fall within the basic rate tax band, the rate of tax will only be 10%, or 18% for residential properties. Above the basic rate tax band, taxable gains are subject to the same rates as executors, 20% or 28%.
There are also further planning options available to make use of as many tax-free allowances and spare basic rate tax bands as possible: assets transferred from the estate to beneficiaries can then be passed to their spouse or civil partner without a tax charge prior to a sale, or by use of a deed of variation assets can be passed to other family members, such as children or grandchildren, who were not beneficiaries of the estate.
If assets depreciate in value after the date of death, the executors of the estate may be able to obtain an IHT refund if they sell the assets before they are transferred to the beneficiaries.
It is important to consider your own personal and financial circumstances carefully when receiving an inheritance because it is very likely that there will be several tax planning opportunities open to you. Please get in touch with a member of our Wills Trusts & Tax team is who will be happy to discuss these options with you and give you advice tailored to your needs and personal objectives.