Inheritance Tax (often referred to as IHT) is the tax levied by government on your estate when you die. The rate is 40% on assets in excess of the Nil Rate Band. The Nil Rate Band is the amount of an estate that each person is allowed to pass on before paying any tax.
“You must pay taxes. But there’s no law that says you gotta leave a tip” – Morgan Stanley
If you want to know roughly what your liability would be then add up your total estate and take off the Nil Rate Band then multiply the remainder by 40% (If you are a married couple you both have a Nil Rate Bands (see below)).
Your estate value is the value of everything that you own, including your main residence, any second property, including assets/property you have abroad, any cash savings and investments you may have, cars, boats, personal effects including jewellery, paintings, furniture or any other valuables you may have and not forgetting of course any life assurance policies not held under a trust.
Currently the amount you are allowed to pass on death before paying any tax (the Nil Rate Band) is £325,000. Generally each year the government increases this threshold though recently this has not been the case, but it has introduced a Residential Property Nil Rate Band for those who pass on properties to lineal decedents and who’s estate is less than £2m
If you are married you are able to pass on to your surviving spouse all of your estate without paying any Inheritance Tax on your death. Previously if you did this then you would have “wasted” your Nil Rate Band (NRB) because, on the subsequent death of your surviving spouse, there would only be your surviving spouse’s NRB for the whole estate.
However from the 9th October 2007, any portion of NRB left unused when a spouse or civil partner dies may be transferred to the surviving spouse or civil partner and used when calculating their liability for Inheritance Tax when they die. So now if you leave everything to your spouse, they will have two Nil Rate Bands available on their subsequent death.
For many people the Government will be the single largest beneficiary of their estate but there are ways of structuring your financial affairs to minimise or even extinguish completely any Inheritance Tax liability.
Inheritance Tax planning need not involve complex and expensive trust arrangements There are options available that will leave you with complete access to your capital at the same time as placing the entire value outside of your estate for Inheritance Tax Calculation purposes. But we would first advise that you make the most of the exemptions available where it is possible and desirable to do so.
Inheritance Tax Allowances, Reliefs and Exemptions
You are able to pass on to your Spouse or Civil Partner on your death any amount free of Inheritance Tax but remember this will need to be passed out of you joint estate on the death of your surviving spouse.
Nil Rate Band
As mentioned above, when calculating the amount of Inheritance Tax Liability, you are allowed to exclude the first £325,000.
From the 9th October 2007, any portion of NRB left unused when a spouse or civil partner dies may be transferred to the surviving spouse or civil partner and used when calculating their liability for Inheritance Tax when they die. So now if you leave everything to your spouse, they then have two Nil Rate Bands available on their subsequent death.
£3000 Annual Gift Exemption
This exemption can be used to cover part of a larger gift or as a stand-alone gift. The exemption is £3,000 for each tax year per donor (giver) and if the full £3,000 is not used in a given year, the balance can be carried forward for one year only and is then only allowable if the exemption for the second year is fully utilised.
Gifts Out Of Income
Gifts can also be made “out of income”. This means that if the gift is made, and it can be shown that the gift was part of the donor’s normal expenditure and comes out of income rather than capital, the gift is exempt from Inheritance Tax. The legislation also requires that the gift should be normal, i.e. the donor had a habit of making such gifts. The legislation also requires that by taking one year with another, the pattern of such gifts must have left the donor with sufficient income to maintain their normal standard of living.
Small Gifts Exemption
Any number of individual gifts up to £250 in any one tax year are exempt as long as they are separate gifts to different individuals.
There are also other exempt gifts, including gifts on marriage, gifts to charity, even gifts to political parties!
Gifts on Marriage or Civil Partnership Exemption
Gifts made by certain individuals in the case of a Wedding or Civil Partnership as follows:
• Parent – up to £5000
• Grand Parent – up to £2500
• Others – up to £1000
Gifts to Charities
Gifts made to charities are entirely exempt from Inheritance Tax. You can also reduce the rate of IHT you pay by giving 10% or more of the taxable value (the value after the deduction of any nil rate bands) reduces the rate you pay on the rest of your estate from 40% to 36%.
Potentially Exempt Transfers
Most gifts that do not fall into the above categories are considered Potentially Exempt Transfers known as PETs. The Inheritance Tax applicable to these gifts depends upon the number of years that have passed between the date the gift was given and the giver’s death.
The rate of tax to be paid has a sliding scale of relief applied to it over seven years which effectively reduces the rate to zero. This is called Taper Relief . NB: Taper relief only reduces the tax payable where the total of gifts in the previous seven years is greater than the applicable Nil Rate Band so in most cases the Taper Relief does not apply.
When death occurs relative to the date of the gift Percentage of full inheritance taxrate payable
Less than 3 years 100%
During the third year 80%
During the fourth year 60%
During the fifth year 40%
During the sixth year 20%
After 7 years have elapsed the PET is no longer treated as part of the estate but care should be taken as there are special rules that govern what can and what cannot be treated as a gift.
Business Property Relief
Apart from using the above exemptions, there are a number of methods of excluding assets from an estate when calculating Inheritance Tax. Many of them involve complex trust arrangements and restrict access to capital and/or income.
However, under Business Property Relief any investments made in “qualifying” Business Property Relief investments are excluded from the Inheritance Tax calculation after only two years. Until recently this involved substantial risk to capital and was only the domain of the brave.
Over the years innovative schemes have been developed that seek to minimise the risk whilst still qualifying for Business Property Relief and we use these schemes to regularly client’s beneficiaries significant sums in Inheritance Taxes whilst allowing the client during their lifetime to remain as the owner and allowing complete access to the capital and income generated by the investment.
Inheritance Tax Planning Advice
You should of course always take professional advice before undertaking any Inheritance Tax Planning and one of our roles as an IFA is to guide you to the most appropriate method of saving Inheritance Tax in the light of your circumstances and objectives.