Unravelling Inheritance Tax
According to unbiased.co.uk, the British public hate only one tax more than Inheritance Tax (IHT), and that’s the money that is taken out of their bank account each month by their local council.
However, IHT is widely misunderstood and this is potentially one of the reasons why HM Revenue & Customs collected £5.4 billion of IHT in 2018/19.
Many individuals mistakenly believe IHT is only for ‘the wealthy’ and comments of “I don’t fall into that category, my children won’t have to pay anything” are commonly heard. Despite this, IHT tax still applies on 25,000 deaths every year.
Complexity of the IHT Rules
The IHT rules currently in place have developed over the past four decades and have now morphed into an over complex legislative structure; with pitfalls, hidden tax charges and lengthy timescales presenting major planning problems.
Due to this, the Office of Tax Simplification (OTS) was asked to review IHT in 2018 by the Chancellor, Phillip Hammond. They have now produced their second report detailing how the web of IHT rules can be simplified, an article on which you can find here.
The recommendations of the OTS however, may not be implemented. For now, therefore, see the below guide on IHT, which highlights some of the problems people face when planning their finances around this tax.
What is Inheritance Tax?
IHT is paid on the estate individuals leave behind when they die. The tax paid depends on the value of the assets that are being left.
What is included in my estate?
The below list is not exhaustive, but your estate is made up of the following:
- Your home and other properties you own;
- Savings, investments and some pensions;
- Chattels; and
- The proceeds of any life insurance policies, subject to being held in Trust.
What is the actual tax charge?
Any assets left above you allowances will be subject to a tax charge of 40%.
How much can I leave?
Individuals can pass everything to their spouse or civil partner free from IHT.
You can also pass up to £325,000 to other family or friends with no tax consequences. This is called someone’s Nil Rate Band.
If an individual’s estate is more than this allowance, IHT may be charged.
In addition, if a spouse does not use their Nil Rate Band on their death, the surviving spouse can use this when they die. For example:
Bob dies and leaves all his assets, worth £600,000, to his wife, Jean.
As Bob passes all assets to his spouse, there is no IHT and he does not use his £325,000 Nil Rate Band.
When Jean dies, she can use Bob’s Nil Rate Band and her own £325,000 allowance.
Jean passes all her assets, worth £625,000, to her sister. With her allowances, there is no IHT to pay.
What about my main residence?
To add an extra layer of complexity, an allowance of up to £150,000 (rising to £175,000 in April 2020), is also available to individuals, which applies to your main residence.
To benefit from this, you must plan on leaving your main residence to your children or grandchildren. The allowance you get is also capped at the value of your property.
If you benefit from this additional allowance, a married couple could leave up to £1,000,000 to their family and friends with no IHT consequences.
This appears straightforward, but what gifts can I make whilst I am alive?
This is where the complexity really kicks in!
Throughout your lifetime, you can make the following gifts, without it impacting the IHT payable on your death or incurring tax when the gift is made:
- Each individual can gift up to a total of £3,000 per year
- This can be carried forward for one year, if not used in the previous tax year.
- £250 can be gifted to an individual per year.
- Unlimited £250 gifts can be made. They must be to different individuals.
- This cannot be combined with the annual gift exemption, above. i.e. £3,250 cannot be gifted to one person.
- Gifts can be given on consideration of marriage.
- £5,000 can be given from parents;
- £2,500 can be given from grandparents;
- £1,000 can be given from anyone else.
- Unlimited gifts can be made to spouses, civil partners, charities and political parties.
- Gifts can be made out of regular income.
- Must be regular gifts, for example monthly;
- Must be made out of surplus income, which is not required to maintain the individual’s standard of living.
But what about larger gifts?
For individuals with larger estates, the above permitted gifts are going to have little or no impact on someone’s IHT liability.
In light of this, there is the possibility of gifting much higher amounts. Inheritance Tax will however apply to a gift, if:
- The gift was made less than 7 years before the death of the person who gave the gift;
- The gift is not covered by any of the above small gift exemptions; and
- The value of the gift, combined with any other gifts within 7 years, exceeds the available nil rate band.
Any gifts that fall outside of these criteria are likely to be free from IHT. It is greatly advised, however, that individuals seek advice on this area before gifting large amounts of money to family or even Trusts.
For obvious reasons, the Office of Tax Simplification report has suggested a number of changes be made to the above rules.
The rules currently represent a minefield for individuals to plan their finances with the objective of avoiding, or mitigating, IHT in mind.
At Informed Financial Planning we have a wealth of experience in helping individuals plan in this area. Whilst we cannot guarantee clients will not pay IHT on their deaths; by planning early enough, it may be that we can reduce the tax liability significantly to ensure your beneficiaries receive as much of your hard-earned assets as possible.
Give us a call on 01482 219 325 or email [email protected] to discuss how we can help you.