Leaving hard-earned assets as inheritance for our loved ones, or as donations to charitable causes we care about, is normal; but with more people filing for divorce, and second or even third marriages becoming increasingly common, family structures are getting ever more complicated.
Resultantly, the potential to accidentally leave inheritance to the wrong people when you die has grown due to complex family arrangements. That’s why it’s essential to implement estate planning early, which includes reviewing any savings, property and investments you have.
An important first step to consider, especially if you are unmarried, is to write a legally valid will to ensure you pass on your estate to the individuals and charities you want to receive it.
Update your beneficiaries
Writing a will lets you make it clear who you want to inherit elements of your estate, such as your main residence and any investments.
It is vital that you update your will after a life-changing event, such as marriage, divorce, having children, or becoming a widow/widower. Failure to update your will can result in part of your estate going to people from your past – this is particularly relevant to divorcing couples.
Over the course of your career, you might work for several different employers and build up a collection of different workplace pension schemes.
These are considered outside of your estate when you die, which means they are not included in your will – unlike other assets such as any property or investments you may hold – and will be paid directly to the beneficiaries you have nominated.
The average pension pot in the UK is worth £61,897, according to the Pensions and Lifetime Savings Association. Most people wouldn’t want that to go to an ex-partner, for example, if it could be avoided.
If your pot is made up of Defined Contribution pension schemes, the full value is usually paid as a tax-free lump sum to your beneficiaries or dependants on death, providing you are under the age of 75 when you die.
All pension providers encourage you to list your beneficiaries and the percentage of your fund you want to leave to them when you die. You can update your nominated beneficiaries by contacting your provider, this is recommended after a change in circumstances.
When you take out protection policies, such as life or critical illness insurances, you must name at least one beneficiary.
Much like a pension, you should contact your provider after experiencing a life-changing event if you wish to update your beneficiaries to reflect your wishes.
Most providers let you do this online, either by logging into your account on their website or downloading a PDF for you to complete and submit.
Everything with estate planning surrounds Inheritance Tax, which is charged at 40% if the value of your estate exceeds £325,000.
On top of this sits the £175,000 residence nil-rate band. This applies to the family home and applies when you pass it on to a direct descendant when you die, protecting up to £500,000 of your estate from tax.
Each individual can use both of these tax-free allowances. For married couples, this can protect the first £1 million in a joint estate from tax. If one of you dies, any unused threshold can be transferred to the surviving spouse.
The role of a trust
Outside of having a legally valid will, one of the simplest ways to protect your estate is to put assets into trust. Dependant on the arrangement, this could mean they fall outside of your estate when you die.
However, there can be tax charges when making gifts into trust (depending on the type of trust and the sum gifted) and if the donor dies within seven years of making the gift.
Trusts are fairly simple to set up and placing pensions and insurance policies into trust is a tax-efficient estate planning strategy, especially when they are not covered by a will.
It is possible to write your pension pot into trust and ensure that any unused money is passed on to your family as inheritance. Whilst the new pension freedoms introduced back in 2015 provide much more flexibility about how and to whom pension deaths are paid, it can sometimes be useful to also use a trust if you have a complicated family structure. A trust might also be needed to keep the death benefits out of the estate if the pension itself is not written in trust, such as for Section 32 pensions or retirement annuity contracts.
In the same way, a life policy can be put into trust. This can be one of the most tax-efficient ways to financially provide for your family’s future after you die. For example, life insurance is designed to pay out a cash lump sum to your loved ones on your death, helping them to pay off the mortgage or provide a regular income.
However, the cash lump sums paid are treated like most other assets and form part of your taxable estate for inheritance tax purposes when you die.
Writing a life insurance policy into trust will result in the payout going directly to your beneficiaries, rather than forming part of your estate.
Setting up a trust involves appointing trustees, such as a family friend, to manage the policy on your beneficiaries’ behalf. They essentially own the policy until you die.
Opting for this strategy ensures the money paid out goes to the right people quickly and without the need for lengthy legal processes, such as applying for probate.
Keep a record
It is quite easy to lose track of pensions, investments and other assets if you do not engage with them frequently. This makes it difficult to keep an accurate record and, therefore, include them without your estate planning arrangements.
To avoid this, you should ensure you keep an up-to-date record of your assets and arrangements.
The content of this page is solely for informational purposes and nothing in it is intended to constitute advice or a recommendation. You should not make any investment decisions based on its content. The impact of taxation (and any tax relief) depends on individual circumstances. This has been prepared based on our current understanding of UK Law, Taxation and HMRC practice, all of which could be subject to change in future. This article constitutes a financial promotion
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