With a combination of rising house prices and a freeze on the threshold at which estates pay inheritance tax means that many more households fall into the tax net than was once the case. In this article we look at how, with some simple planning, it is possible to keep your inheritance tax liability to a minimum.
Currently each person has an inheritance tax allowance of £325,000 on which no inheritance tax is paid. This is called a nil rate band. This allowance is transferable between spouses, so a married couple can give away a total of £650,000 tax free when they die. Anything over the nil rate band is charged to inheritance tax at 40 per cent unless any of the following apply:
- Spouse exemption – gifts between married couples or civil partners do not attract inheritance tax
- Charity exemption – any amount can be gifted to a UK registered charity free of inheritance tax
- Business property relief and agricultural property relief – inheritance tax is either not payable or reduced on certain business and farming interests
From 2017, if your estate includes a main residence, you can reduce your tax bill by passing it direct onto your descendants. The full detail of the legislation is still under consultation, but current government guidance is that each individual’s estate will benefit from an additional allowance of £175,000. The allowance will be tapered in from 2017 to 2021, and is subject to conditions. This means that by 2021 each person could pass on £500,000, and £1,000,000 for couples.
Inheritance tax example
A useful tool for inheritance tax planning is your will. When you are making a will, you can set out how you want your assets to be distributed when you die, and take advantage of tax exemptions. Making a will is especially important in light of the new residence allowance. You will need legal advice if you own your home jointly with your spouse, as it may not pass under your will.
Mr and Mrs Smith are married and have an estate of £800,000 made up of their house and investments. Mr Smith dies first leaving everything to Mrs Smith, who then leaves her estate to their children on her death. At the current rates, on Mrs Smith’s death, £650,000 would pass to the children free of inheritance tax and £150,000 would be chargeable to inheritance tax at 40 per cent.
However, if either Mr or Mrs Smith dies after April 2017 and their estate includes a main residence (or did so before July 2015) that they leave in their will to their children, it is possible that there will be no inheritance tax as a result of the new nil rate band allowance.
Reducing the size of your estate
Inheritance tax is a voluntary tax to the extent that it is possible to avoid it by giving assets away. If you survive seven years from the date of a gift then no inheritance tax is payable on the amount given. This means that it is important to start planning early. If you die within seven years, then the value of the gift is taxed as if you still owned it.
You can gift away the following without the need to survive seven years:
- £3,000 in total per year
- Small gifts of £250 to separate individuals
- Any amount as long as it is paid out of income that is surplus to your requirements
- Gifts in contemplation of marriage varying from £1,000 to £5,000, depending on your relationship to the person marrying
Incorporating a trust in your will can sometimes help to save on inheritance tax. This can be particularly so for spouses who own business assets or where assets that grow faster than the nil rate band over time are placed into trust on the death of the first to die. Trusts can also be used during a lifetime to gift assets that you do not want to pass to beneficiaries outright. Unless assets qualify for inheritance tax reliefs, such as business relief, the maximum you can pass into a lifetime trust without paying lifetime inheritance tax is £325,000 every seven years. It is important to take into account income tax and capital gains tax considerations when setting up a trust.
Using deeds of variation
In certain circumstances deeds of variation can be used to reduce inheritance tax in an estate. It is possible to enter into a deed of variation up to two years after a person’s death.
Independent Financial Advisors offer investment wrappers that can help you to save inheritance tax. These include investments in shares that qualify for business property relief after you have held the shares for two years.
What not to do
If you give assets away and continue to benefit from them in any way, the gift will not be effective for inheritance tax purposes. This means that the value of the assets will be taxed in your estate as if they were still yours.
People often consider giving away their home to save tax. Giving away your main property to avoid inheritance tax is only effective if you pay a market rent for your occupation, which may not be affordable. If your home is your main asset, it is rarely a good idea to compromise your security by gifting it to another.
Remember that it is important to ensure your future wellbeing. All inheritance tax planning should be proportionate and balanced, taking into account your needs for the rest of your life. While you may be able to afford to give assets away now, you need to consider carefully what your income requirements might be in years to come, particularly if you were to require residential or nursing care.
For further advice on making a will, deeds of variation or inheritance tax, contact 01732 747900 or email [email protected]
The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice, and the law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.