What is Inheritance Tax and what can I do about it?
Inheritance tax with house prices having soared
The days of Inheritance Tax (IHT) being only a concern for the wealthy are in the past. The nil rate band (NRB) of £325,000 has been frozen since 2009 and continues to be so until at least April 2028. The recent increase in property prices means more estates are facing an Inheritance Tax bill.
There is another allowance which helps to shield the tax on the family home which is called the Residence Nil Rate Band (RNRB). The current RNRB is £175,000. Like the nil rate band, this is transferrable between married couples and civil partners. For a couple whose home is worth more than £350,000 it means a combined total of £1m could be left to their direct descendants. The RNRB is quite complex in how it works so it is too simplistic to assume it always applies.
Transfers between spouses and civil partners and gifts to charities are exempt from IHT but, if all or part of the estate passes to other individuals, it will fall within the charge. The people who benefit from the estate pay the tax out of the assets inherited. The IHT charge is calculated based on the assets left by the deceased and on certain gifts made within the seven years prior to death. The tax charge is 40% on assets over the nil rate bands.
How can I reduce my family’s exposure to IHT?
Planning to reduce your family’s exposure to IHT is most effective if it is started early. A lifetime gift is known as a Potentially Exempt Transfer (PET) which means it will only be exempt from the IHT charge if made more than seven years prior to death. Gifts made between 3 and 7 years before death might have a reduced tax charge, depending on the circumstances. After 7 years the NRB is restored which, in practice, means that over many years a substantial amount of money can be gifted away tax free.
Gifts to individuals will inevitably reduce your capital and, potentially, income too. You will have no control on how the donee uses those funds. Families, considering their own circumstances, would need to consider if this would be right for them.
Individuals have an annual tax-free gift allowance of £3,000 which is exempt from IHT. Where the one for the previous year has not been used this is carried forward for one tax year, with the current year’s allowance taking priority. You can also make as many gifts as you wish of up to £250 per recipient per tax year, where no other relief has been used for gifts to the same person.
A valuable IHT exemption which is often overlooked is gifting out of income. This applies to gifts made from surplus net income and must form part of the donor’s normal expenditure.
There is an exemption for lifetime gifts for a marriage or civil partnership. The amount depends on the relationship between the donor and the donee. Children or grandchildren of the donor can be gifted £5,000 and £2,500 IHT-free respectively but for anyone else the exempt amount is just £1,000.
Maintenance payments for certain family members can be free of IHT. There are three broad categories of this relief. Firstly, it covers he maintenance of spouses or civil partners. This would normally be covered by the spousal IHT exemption (although not always where one spouse is not domiciled in the UK). As it also includes ex-spouses, any maintenance as part of a divorce settlement can be included.
The second category is maintenance and education for the children of the taxpayer and those of their spouse or civil partner. The definition of child here includes those over age 18 but still in full time education, such as those at university. This might include their accommodation, food and university fees, giving an opportunity to gift significant amounts tax free.
Thirdly, maintenance and care of an elderly relative of either the taxpayer or their spouse or civil partner. Unlike the position of the spouse or civil partner and children, this provision may be for ‘care’ or maintenance, but it must be reasonable.
Good planning and making use of the exemptions available can make a big difference to your family’s overall IHT exposure.
Trusts can be used to protect family wealth for future generations and can also be effective in protecting assets from claims from those outside of your bloodline. An added benefit is retaining some control of the assets held within it beyond your lifetime.
Life assurance policies can also be used as a means of protection against IHT liabilities. These are generally written in trust so that the proceeds fall outside your estate but are available to settle the IHT liability.
Certain assets benefit from IHT relief. These include Business Property, Agricultural Property and Heritage Assets. These reliefs can reduce or even eliminate the value of an asset in an estate, but there are certain conditions which must be met. Not all business assets will qualify for these reliefs.
Wills and Deeds of Variation
Where 10% or more of the deceased’s net estate is left to charity, the estate qualifies for a reduced rate of IHT of 36%.
If a Will is not tax efficient then this can be varied via a Deed of Variation within the two years after the death, if the beneficiaries agree.
What else should I do?
Although it might be difficult to think about it, we would always encourage making a Will. The benefits are plentiful.
Dying without a Will can cause increased legal fees, unexpected beneficiaries and unwelcome tax consequences. Leaving a Will gives those left behind clear guidance and gives the executor an immediate right to manage your affairs. Without a Will they would need to wait until they were officially appointed as administrators before taking control.
Making a Will with a knowledgeable solicitor might also give you a valuable opportunity to review your Inheritance Tax exposure.
Please get advice
This article is only a brief outline of the rules, which are complex, and is not intended as advice because everyone’s circumstances are individual. We would recommend that you seek professional advice to ensure the maximum wealth possible passes down to your chosen beneficiaries.