What is estate planning?
In this guide we explain the practicalities of estate planning and why everyone needs a plan. Find out why making a will is so important and how inheritance tax can impact what you leave behind. By the end of this guide, you’ll have a greater understanding about estate planning and what it entails
Key takeaways
- Estate planning is important. It removes any dispute about what to do with your estate and provides clear guidance for your loved ones.
- Setting up a will is the first step to take when estate planning. With a will, you get to decide who your beneficiaries are and how much money they receive. Next, make a list of all your assets and work out how much they add up to. If your assets total more than £325,000, think about how inheritance tax may impact what you leave behind.
- You don't have to be rich to benefit from estate planning. But you should investigate taking professional advice if your estate is large or complex.
What is estate planning?
When you’re considering how to pass on your wealth when you die, you’ll want to make sure it goes to the people you choose. This is estate planning. It helps make sure that everything you own is passed on in the way you want it to be.
You don't have to be rich to benefit from estate planning. Anyone who has savings, owns property, has a pension or even a collection of Dinky toys can plan who they want to receive their estate when they die.
Your estate is made up of all the assets you own. It includes:
- your home and car
- your savings and investments
- your personal belongings, such as jewellery, art and furniture
- a life insurance payout.
Remember though that if you own assets jointly with other people, to only include the proportion that belongs to you.
Estate planning is important because you can make it clear in advance who receives what when you die. You can also put plans in place if you become unable to manage your own financial affairs as you get older. This removes any dispute about what to do with your estate and provides clear guidance for your loved ones.
If you don't have a plan in place for what happens to your estate when you die, you could find that the Law determines who gets what. This is called being ‘intestate’. It means that you died without making a will. This may mean that your wealth doesn’t end up with those you choose.
An example of this is unmarried partners. If you die without making a will, your unmarried partner is not entitled to automatically inherit your wealth. Instead, your estate will go first to any legal spouse or civil partner (even if you’re separated). Then children and their descendants will inherit if there is no legal spouse.
You could also find your estate is landed with a large inheritance tax bill if you don’t take steps to plan ahead. Estate planning can help minimise the amount of inheritance tax you may need to pay.
Learn more: Life insurance payouts explained
The estate planning process
The estate planning process involves looking at all aspects of your finances. You will need to make a comprehensive list of everything you own. And then decide who you want to leave it to.
As part of the process, you may need to draw up various legal documents. At this stage it’s a good idea to speak to a professional, such as a solicitor, financial adviser or will writer. They’ll make sure everything is recorded correctly.
Estate planning is also an ongoing process. As your life changes over time, you’ll need to review your plan. Here’s how to plan your estate:
1. Making a will
Making a will is one of the most important components of estate planning. A will is a legal document that sets out how you want your estate to be divided up. Without a will in place, the rules of intestacy decide who gets what.
In your will you can decide which people or organisations will receive your assets. For example, you can set out how much money they receive, who inherits your jewellery or which charities will benefit. These people or organisations are called beneficiaries. You can also stipulate what happens to your assets if any of your beneficiaries die before you do.
To become a legal document, you must sign your will in front of two witnesses. And your two witnesses must sign it in your presence. If you change your will, any changes must go through the same signing process.
Learn more: Appointing an executor of a will
2. Paying inheritance tax
Inheritance tax (IHT) is a tax on the estate of someone who has died. If your estate is worth less than £325,000 when you die, then it won’t have to pay any inheritance tax. The amount up to £325,000 is known as the ‘nil rate band’ because the inheritance tax you pay is nil if you stay below it. Any amount above this inheritance tax threshold could be taxed at 40%.
You can also pass on up to £175,000 more, free from inheritance tax, if you leave your share of your main home to your children or grandchildren. This amount is known as the ‘residence nil rate band’. Together, these two nil rate bands add up to £500,000 per person.
There’s no inheritance tax paid between spouses or civil partners. So, you can pass on your inheritance tax allowances to your partner. This gives them an extra allowance of up to £500,000 after you’ve died.
If you think your assets add up to more than the allowances, you may want to consider how to pay less tax. There are various strategies you can use to reduce your IHT bill, such as making gifts and setting up trusts. We outline some of these below.
Inheritance tax planning can be a hugely complex area. Speak to a financial adviser before you reorganise your finances.
Learn more: Life insurance and inheritance tax explained
3. Setting up a trust
A trust is a way to take your assets out of your estate, so you won’t need to pay inheritance tax on them. Anything can be put into trust, including property, possessions and cash.
A legal agreement is set up so that the trustees – the people who run the trust – become the legal owners of the assets. This means they no longer belong to you. As part of the trust, you can request that certain people benefit from the assets, such as your family. There are two main types of trust: discretionary trusts and life interest trusts.
A discretionary trust is a way to remove money from your estate but allow your beneficiaries access to it during your lifetime or after your death.
A life interest trust allows your beneficiary an interest for life in the assets in the trust after you die. They won’t ever ‘own’ these assets, and when they die, they’ll pass to your chosen beneficiaries.
Learn more: Life insurance and trust explained
4. Gifting your assets
Giving away, or gifting your assets, is a useful way to reduce the value of your estate and therefore your inheritance tax bill. Gifts can include cash, personal possessions, household goods, property, land and investments.
There are rules around how much and when you can make gifts that are exempt from IHT. Generally speaking, there are two types of gift. Those that are immediately exempt from IHT and those that become exempt over time.
Immediately exempt gifts include an annual gift allowance of £3,000 which you can use once a year. And a small gift allowance of £250 – which you can use as many times as you like in a year. Gifts made to a couple in the year of their marriage are also exempt from IHT as are gifts made out of your regular income.
Most other gifts only become exempt from IHT seven years after the gift was made. However, if you die before the seven years is up, the whole amount gifted falls back into your estate and uses your nil rate band up first. This pushes more of your estate into 40% tax.
Life insurance and estate planning
One way to mitigate the cost of a potential inheritance tax bill is to take out a whole of life insurance policy and place it in trust. If you put your life insurance policy in trust, it’s owned by the trustees and therefore sits outside of your estate. This means it can be paid out straightaway, free of all taxes and without waiting for probate. It can then be used to pay all or some of your inheritance tax bill if you have one or be paid to your beneficiaries for them to use as they wish.
Funeral planning as part of estate planning
As part of estate planning, you can also plan ahead for your funeral. It’s an opportunity for you to talk to your family about your wishes, so your family know how you’d like to be laid to rest.
Pre-planning your funeral can help alleviate the financial and emotional cost of planning a funeral for your family. They will have a record of your wishes and be able to incorporate them in the arrangements.
You can choose to pay for your funeral in advance with a prepaid plan. Alternatively, you can take out an over 50s life insurance plan. This pays out a lump sum when you die which your family could use towards paying for your funeral.
Learn more: Life insurance and funeral planning explained
What are the benefits of estate planning?
There are four main benefits to estate planning.
1. Making sure your wishes are carried out. By making a will, you can make it clear in advance who receives what when you die.
2. Supporting your loved ones. Having a clear understanding about the size of your estate can help you work out how to help loved ones now and when you die.
3. Minimising taxes and legal complications. Taking steps early to mitigate inheritance tax could mean more of your estate goes to your family rather than the Treasury. And taking financial and legal advice will help make sure your affairs are watertight.
4. Peace of mind. There’s a lot to be said for putting your finances in order. It’s reassuring to know you’ve planned ahead.
Estate planning – things to considerEstate planning can be complex. Making a mistake in your will or setting up a trust wrongly can be very costly. It could mean your family do not receive your assets in the way you intended. |
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