So what is Inheritance Tax, or IHT as it’s also known?
When you die, the assets that you leave behind are known as your estate – things like your possessions, savings and investments, and property. If your estate is valued above a certain threshold, IHT may be charged on it. The normal rate of inheritance tax is 40% in 2020.
With many people owning their own houses, the potential value of their estate can be quite high given current house prices. However, there are significant allowances and reductions which may be used to protect a good deal of your estate from IHT.
Often, people with an estate that exceeds the threshold end up with no IHT liability at all. Some of the available mitigations kick in automatically, while others require planning.
What is exempt from IHT?
There are basic reliefs and exemptions from IHT, these include:
- Anything left to your spouse or civil partner is not subject to IHT. The same applies for assets which you leave to a charity.
- Each individual has a tax-free threshold. In 2020/21 this is £325,000.
- If you leave more than £325,000 in value of assets, only the excess is subject to IHT.
- If you are married or in a civil partnership, you can effectively pool this allowance with your partner, removing the first £650,000 from the scope of IHT.
- There is an additional provision to protect the estates of parents and grandparents when passing on a main residence to children or grandchildren. It is a residence nil-rate band, informally known as the family home allowance, and in 2020/21 it’s worth £175,000 each (for estates of up to £2 million). Again, it can be pooled between spouses.
What else can you do to reduce your liability?
If your estate still faces a potential liability after taking into account the basic reliefs and exemptions, there are still ways in which you can further reduce your IHT liability. Chief among these is giving gifts while you are still alive.
These gifts can be of cash, but they can also be of possessions or property (also see later in this article). So,
- Small gifts of up to £250 per person, per tax year
- Normal gifts that come from your income rather than savings, which don’t reduce your standard of living
- Money which assists with living costs for another person, like a child under the age of 18 or someone elderly
- Political or charitable donations
- Wedding (or civil ceremony) gifts valued at £1,000 per person, £2,500 per grandchild, and £5,000 per child.
The gift of a property
Providing you survive seven years after the giving of a significant gift, such as property – known as a potentially exempt transfer – regardless of value, then that gift falls out of the scope of IHT. Even if you were not to survive that long, you may still pay less inheritance tax should there be liability.
The full 40% tax rate stands for the first three years after the gift and then a sliding scale is activated.
Bear in mind that it must be a genuine gift, given unconditionally without reservation. An obvious example of a gift that would fail this test is if parents gave their house, or a portion of it, to their children, but continued to live in it as if it were their own.
This would not qualify as a gift, although the residence nil-rate band may come into play to prevent IHT being due.
This form of gifting can be a very effective way to lower IHT liability – as long as it is properly planned and done correctly. We always recommend that you take specialist professional, legal advice before proceeding.
If you are looking at more complex IHT planning opportunities, please remember …….
The above rules will cover the vast majority of straightforward cases. However, as with most tax planning, there are a number of different circumstances and situations which could affect you.
One way to achieve a small reduction in the tax rate is to leave 10% or more of your estate to charity. This reduces the rate of IHT on the remainder of the estate from 40% to 36%.
Gifting to a trust is a specialist area of IHT planning on which you should consider taking professional advice if you wish to explore options.
Owning business assets, or agricultural land, which is part of a working farm or separate woodland, may be a factor which can trigger full or partial exemption. Please seek advice.
Some final things to consider
- ensure you keep your will up to date;
- your situation may be more complicated if you are not domiciled in the UK;
- if you own property jointly with someone who is not your spouse, do not take for granted what will happen to the property if one of you dies. Seek advice.
- Usually, no one pays tax on the first £325,000 of their estate, and any of the following has the potential to add further protection:
- Leaving your estate to a spouse or civil partner
- Passing on a primary residence to children or grandchildren
- Making charitable or political donations
- Giving gifts within prescribed rules
Tax matters such as IHT can be a minefield to navigate if you’re not familiar with the territory. That’s why we always recommend that you seek professional advice on these matters. If you’re unsure of who you can turn to, our Tax Team are here to help. You can contact them on 0161 923 0201 (option 3) or email firstname.lastname@example.org.