We hear a lot of people telling us that Inheritance Tax (IHT) doesn’t apply to them or that it’s not their problem. This is understandable as people tend to imagine the tax as only impacting upon the super rich, plus that fact is that it only kicks in once you die.
However, what people might not realise is that with the impact of property prices in recent years, combined with a lack of movement in the Nil Rate Band (the value your estate can reach before IHT is due) means that more people than ever are potentially liable to the tax.
This is one of the reasons that most people think IHT is the most unfair of taxes – you work hard and pay tax all your life to amass some wealth and assets, and the government helps itself to an additional chunk of tax when you die before you can pass your estate to your family.
But how do they work out what that chunk will be and who will it affect?
The general rule is that each person is entitled to £325,000 worth of assets, and anything they own in excess of this amount is taxed at 40% on death. Married couples effectively have two of these allowances, so can own assets of up to £650,000.
Barbara and Alan own a house worth £500,000 with no mortgage. They have £70,000 premium bonds, £50,000 ISAs and £100,000 worth of cash savings. Barbara has a collection of antique jewellery from her Mother, worth £30,000 and Alan has a vintage car worth £150,000.
The total value of their combined estate is £900,000, meaning that the potential IHT due on the second death is £100,000.
This illustrates that even modest wealth can lead to hefty IHT liabilities – but there are things you can do, and the IHT is something you need to take into account when planning how your estate will pass to future generations.
The Family Home
It’s not all bad news though. A new residence nil rate band is being phased in from April 2017. This will initially be £100,000 per person and will increase £25,000 each tax year until it reaches £175,000 by 2020-21. Any unused band should be transferable to a partner and the relief will apply when the main residence is passed to a direct descendant.
It will be reduced if your estate exceeds £2m but for those mid sized estates, it effectively increases the nil rate band to £500,000 each, saving up to £140,000 in inheritance tax per couple.
Anyone who wants to downsize to a smaller property will be eligible for an “inheritance tax credit” so that they will still qualify for the nil rate band provided the bulk of the estate is left to direct descendants.
Normally, if you give away money or assets, the gift remains part of your estate for 7 years. If you die within 7 years the IHT could be due on your gifts, depending on the value of them (they use your nil rate band before the rest of your estate on death).
If IHT is due, relief can be available depending on how long ago the gift was. Once the 7 year milestone is reached, your nil rate band effectively ‘resets’.
Gifts to your spouse or civil partner are totally exempt from IHT (as long as you are both UK domiciled).
Finding gifts that are immediately exempt (rather than having to wait 7 years) is therefore a useful tool for reducing your IHT bill quickly.
There are a number of very simple methods of saving small amounts of inheritance tax.
- Everyone has an annual gift exemption of £3,000 which can be carried forward for one year if not used (the gift can be more than £3,000; the first £3,000 will be exempt)
- There is a small gifts exemption of £250 per recipient per year (the gift must be less than £250 to be exempt)
- Gifts on the occasion of marriage of up to £5,000 depending on your relationship to the bride and groom are exempt from IHT
- Gifts to Charities and Political Parties are also immediately exempt (and incidentally, any estate where 10% of the value is left to charity qualifies for a reduced rate of IHT, being 36%)
Regular gifts out of income
If you have a lot of surplus income (i.e. you earn more than you spend), then a little known trick is to give gifts out of this extra income. There are rules to adhere to but this automatic exemption can be extremely valuable.
E.g. Craig has annual income of £90,000 after tax. His living costs amount to £30,000 per year and he spends a further £30,000 on entertainment and holidays. The remainder tends to be saved.
Instead of saving this income, Craig could give it away on an annual basis, either to pay school fees for his grandchildren or for Christmas gifts etc. and the gifts would be immediately exempt from IHT.
There are some formalities to securing this relief (which is important because if you don’t, then the 7 year period applies), and record keeping is very important.
Businesses and agricultural property
Businesses and agricultural property are often exempt from IHT; however there are nuances and criteria in the legislation which could prevent the reliefs applying in some rather unexpected ways!
Care must be taken – some small changes to a business or farming arrangements during your life could make a big difference to the availability of reliefs!
For example if you have a trading company but there is a lot of cash held in the company bank account, this could limit or remove the availability of Business Property Relief; whereas paying a dividend, investing in equipment or using the cash in some other business related way could protect the relief.
Writing a will
It is vital for everyone to consider whether they should write a will; dying without one in place can cause a headache for your family and means that you may not have control over who receives what!
A simple will can be drafted for minimal cost; but they can also be used as a toll for asset protection and future inheritance tax planning, through the use of Trusts.
There are many types of trust and the rules are complex, but they can be set up during life or on death (there may be tax consequences so professional advice should be sought).
They can be used to ring fence assets outside of your estate, to skip generations for IHT purposes, provide for certain individuals or groups of people, to protect assets from warring families or irresponsible individuals, they can be used to protect wealth from divorce and a myriad of other reasons.
Lifetime use of trusts can offer a great way to provide for your (adult) children or grandchildren of any age. You can also provide for unborn individuals if you wish.
They offer the opportunity to ‘use up’ a nil rate band, and then provided you survive seven years, you can consider making another trust or more gifts, as a new nil rate band will be available.
Capital Gains Tax
Whilst capital gains tax is not sue on death, it should be noted that it can be charged on any assets given away during life. Stamp duty land tax could also apply.
There are a number of things you can do to actively reduce your IHT liability; there are few situations with a catch all solution which eradicates IHT. Instead, IHT planning is more nuanced, with varying solutions to reduce IHT or protect against exposure on an asset by asset by asset basis, depending on your circumstances and wishes.
That’s where we come in; we can help you to assess the likelihood and extent of suffering IHT and work in partnership with you to tailor solutions that suit your needs. We work closely with solicitors and financial advisers to come up with bespoke planning which helps you achieve your goals for your family, and ensure that you have peace of mind about what will happen to your estate when the time comes.
If you’d like to come in to discuss your needs, please contact using the request a call back button below