Your guide to estate planning

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.

Key components of an estate plan:

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

Inheritance tax and estate planning

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

Setting up trusts

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 exlained

Gifting 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

Estate planning – things to consider

Estate 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.

That’s why it’s important to get professional help. Speak to a financial adviser before you set up a trust. And check your will with a solicitor or will writer to make sure it’s legally correct.

Consider appointing a Power of Attorney. These are people you trust to make decisions for you if you lack mental capacity. They can take on the responsibility of looking after your finances and your health if something bad happens to you.

Start estate planning now. You never know what’s round the corner. Make sure your loved ones know your wishes. Review your plans at least once a year, or if there’s a significant change in your life.

Keep your finance above board. Trying to evade your taxes can have damaging repercussions and is illegal.