What is Inheritance Tax (IHT)?
IHT is a tax on the estate of someone who has passed away, including the value of all their property, possessions and money. The standard rate of tax 40%, which is charged only on the part of the estate over the tax-free threshold of £325,000. There are various reliefs available, and with careful planning during a person’s lifetime, IHT can be mitigated as much as possible, through exemptions and by making tax efficient wills and lifetime transfers.
What reliefs are available?
Nil Rate Band (NRB)
Available to every individual
Residential Nil Rate Band (RNRB)
Available to every individual when gifting their primary residence to their direct decedents (children, grandchildren etc).
up to £325,000
Gifts between spouses are exempt of IHT. When the first of a married couple dies, any of the unused NRB can be transferred to the estate upon the second death, meaning a married couple could be worth up to £650,000 tax-free.
up to £175,000
For the estate of a married couple, the unused RNRB relief from the first death can also be transferred and used upon the second death, with a potential combined tax-free estate of £1m.
Which allowances and exemptions are available?
The following are available to all adults in the UK and can be used to reduce the value of an estate, without being taxed:
£3,000 per year
An annual exemption allowing you to make a maximum gift of £3,000 per year, including to one person, or gifts to multiple people in a year which totals £3,000.
£250 per year
In addition to the above, an annual allowance of gifts of £250 per year, to an unlimited number of people.
Wedding gifts of up to £5,000 to a child, £2,500 to a grandchild or £1,000 to any other person.
A gift out of ordinary income, which is used from your net income (after tax) and is gifted on a regular basis. For example, paying monthly into your child, or grandchild’s, savings account. For this relief to be available HMRC would expect to see a regular pattern of payments being made, and only from your net income.
Potentially Exempt Transfers (PETs) and the “7-Year Rule”
The value of any gift, or transfer of assets, that you make outside of the above exemptions and allowances, will still be considered part of your estate, if you pass away within 7 years of the date of the gift / transfer. For example, if you create a trust but pass away 2 years later, the value of the asset in the trust is still considered by HMRC to be part of the value of your estate, and IHT will still be due (but only if your estate is over the threshold). The rate of tax is tapered after 3 years, so the closer you are to 7 years when you pass away, the lower the rate of tax will be (if tax is due at all).
Exceptions to the “7-Year Rule”
Generally, if you survive a gift or transfer by 7 years, the value of the asset will fall out of your estate. The exception to this rule is if you have retained any benefit of the asset. For example, if you put property into trust but still continue to live in it, HMRC will consider it to be a Gift with a Reservation of Benefit (a ‘GROB’) and the value will still form part of your estate.
Mitigating your IHT liability
For clients who are above the IHT thresholds, for example a single person with no children being worth £400,000, or a married couple with children being worth a combined £1.2m, there are ways to reduce the potential IHT liability. You should make full use of the annual allowances and exemptions listed above, as well as considering other methods including:
Transferring assets to a trust but surviving them by 7 years and also retaining no benefit of the asset will remove its value from your estate. For example, adding a rental property to a discretionary trust, with the income either being left in trust or paid to a particular beneficially (such as being used to support grandchildren).
When including gifts to charities in your will, the gift itself is free of IHT, but if you gift at least 10% of your net estate, and your estate is over the threshold for IHT, then the rate of tax will be reduced from 40% to 36%.
Business Relief (BR) is available for business assets and the value of those assets are generally free of IHT. For example, a self-employed joiner who owns various machinery as part of their business, the value of that machinery will attract 50-100% IHT relief.
Investing money in some types of investments, including life insurance policies and shares which attract BR may also reduce your IHT liability. You should seek financial advice regarding investments (Alexander Legal Services is not regulated to provide financial advice).
Clients who transfer assets to reduce their IHT liability should also take note that if the asset has increased in value since it was purchased, then Capital Gains Tax (CGT) may be payable, albeit usually at a lower rate of tax than IHT.