Some areas of tax and financial planning which you might want to consider in light of an inheritance
That might be a bit of a shock, especially to younger people who are perhaps hoping that an inheritance is likely to get them onto the housing ladder in their twenties, or thirties. Unfortunately, for those in the 25-34 age bracket, the average inheritance is even lower, standing at £5,000.
This is not to say, however, that you mightn’t come across a larger inheritance (perhaps £100,000 or more) in your twenties, thirties or later. When this happens, it can be difficult to know exactly what to do with the money. Should you use it to buy a house outright, for instance? Should you simply put all of it into a savings account?
In this short guide, we’ll be suggesting some areas of tax and financial planning which you might want to consider in light of a large inheritance. This content is for inspiration and information purposes only, and should not be taken as financial advice. To attain regulated, personalised financial advice into your circumstances please consult a professional financial adviser.
There might be all sorts of emotions tied up with receiving an inheritance, due to the tragic circumstances in which people typically receive one (e.g. parental death). Yet it’s important to try and be objective and to ask yourself what you should do with your inheritance in the same way you would ask what to do with any large amount of money which suddenly came your way. It might be tempting to begin by thinking about investing, but a good place to start is to look at your debts. After all, the high APR on many credit cards - sometimes as high as 14% - is likely to overtake the returns on many of the investments you might be considering. From there, it can be sensible to look at your emergency savings and ask yourself whether you have an adequate “safety net” in the event of unemployment or a sudden, large expense (e.g. a roof replacement on your home). A good starting point here is to seek to build up at least 3-6 months of living costs in an easy-access savings account, such as a Cash ISA.
How might a large inheritance feature within your financial plan? In particular, how might it help you achieve your financial goals? It could be that you aim to retire early in your mid-fifties, and so investing some (or all) of your inheritance money into your pension might be worth considering. Alternatively, perhaps your primary goal is to live mortgage-free as soon as possible, and an inheritance lump sum could help you achieve this.
Hidden Obstacles
It’s important to discuss these ideas with your financial adviser, as there can be lots of hidden obstacles standing in your way which will be important to address. For instance, if you want to put a large sum of money towards your pension then you will need to navigate the Annual Allowance. In 2020-21, this limits your tax-free pension contributions to a maximum of £40,000 per year or up to 100% of your earnings (whichever is lower).
So, if you’ve inherited £100,000 and want to put it all towards your pension, you might need to consider spreading these contributions across five or more tax years. You will then need to talk carefully with your adviser about what to do with the rest, in the meantime. For example, you can commit up to £20,000 into your ISA(s) without facing tax on the interest you make.
Tax Efficiency
However, the rest of the money will need to be dealt with somehow, in a tax-efficient manner. Here, it might be sensible to open a regular investment account (which would be subject to capital gains tax and dividend tax) to act as a “holding pot”, until the remaining inheritance money can be moved tax-free into your ISA(s) or pension over the following tax years.
You will also likely need to factor in the Lifetime Allowance into your potential decision to invest all of your inheritance money into a pension.
This refers to the maximum amount you can have saved into your pension(s) without it facing tax, and in 2019-20 this limit is £1,073,100. Of course, £100,000 put into your pension right now might not look like it will take you over this limit.
However, if this and your other pension savings grow at, say, 7% or more (on average) over two or more decades then the money could potentially exceed this threshold, with some people failing to even realise. Again, speaking with a financial adviser will help you run several different financial “scenarios” like this, to determine their likelihood and plan accordingly to help ensure you do not inadvertently end up paying more tax than you need to.
Your Partner
One option if you are married or in a civil partnership is to consider their tax-free allowances. Remember, each of you gets a tax-free ISA allowance of £20,000 in 2020-21, so between you, this potentially offers a £40,000 “tax wrapper” to help contain a large inheritance. You also both get an individual annual allowance of £40,000 (or up to 100% of your earnings) for your pension as well. So this could be another option to consider to help you reach your joint retirement goals whilst saving on tax in the short term.
As stated previously, the best course of action is to speak to an experienced financial adviser if you have received a large inheritance, and you want to get the best out of it. The financial benefits and peace of mind gained from the advice are likely to far outweigh its costs.
Read our guide to Inheritance Tax - what it is and how to mitigate it.
Inheritance Tax or IHT can be complicated, but your major beneficiary doesn't have to be HMRC. Read the guide