What is Inheritance Tax? (IHT)
IHT is potentially payable on all the assets which pass on when you die, and at 40% it can make a big hole in them. Not only that, things which you have given away in the past can be dragged back into the tax net when you die. Worse still, many people make so-called gifts which are not considered to be genuine gifts by the Taxman, the most common being gifting your house to your children but continuing to live in it without paying a regularly reviewed full market rent, which rent would be potentially taxable in your children’s hands.
Who is responsible for paying IHT?
The executors of the estate are responsible for arranging payment by the end of the 6th month after the month in which the person died. Until payment has been agreed and made with the Taxman, Probate cannot be granted and beneficiaries just have to wait.
What is the current Inheritance Tax threshold / tax-free allowance?
In most cases, the current threshold is £325,000 for an individual and £650,000 for a married couple or civil partners. The unused nil-rate band can be passed to the surviving spouse or civil partner on death. The joint allowances do not apply to so-called common law spouses.If one partner has already died, the allowance could be the full £650,000, provided everything had been left to the surviving partner. If not, it will be proportionally reduced.
But what about the residence nil-rate band?
This new nil-rate band will apply if you want to pass your main residence to a direct descendant like a child or grandchild (including step, adopted or foster children). It’s important to note that as only direct descendants can benefit, not everyone will be able to rely on it for IHT planning purposes. This means that many Wills need to be re-written to save up to £140,000 in Inheritance Tax (contact us if you need a recommendation).When added to the existing threshold of £325,000 this could potentially give an allowance of £500,000 for those who are single or divorced, or £1m for those who are married or in civil partnerships.BUT larger estates will find that residence relief is tapered; it reduces for estates worth over £2m. The allowance is reduced by half of the value over £2m – so at £2.2m the allowance is reduced by £100,000 = £40,000 of extra tax to pay.
Save Tax with the 7-year rule?
Gifts made during your lifetime are ‘potentially exempt transfers’. After 7 years, in most cases, they drop out of the IHT net. If you die before the 7 years is up, then there may be a discount of the amount charged to tax which is called Taper ReliefYears between gift and death Rate of tax on the gift3 to 4 years 32%4 to 5 years 24%5 to 6 years 16%6 to 7 years 8%7 or more 0%Gifts must be outright, and you can no longer benefit from them. So, if you were to gift your home, but continue to reside there without paying a commercial rent, HMRC would consider this to be a ‘gift with reservation of benefit’ and include the value as part of your estate unless you can prove that you have paid a full market rent reviewed annually (and that the rent has been taxed in the hands of the beneficiaries, who could end up in Court themselves!)
Can I make tax-free gifts?
Important Note: when is a gift made?
If by cheque it is made when the money clears into the beneficiaries bank account – so be very careful with last minute gifts in the tax year!Each financial year you can make gifts of up £3,000 (in total, not per recipient) and if you don’t use this in one tax year, you can carry over any leftover allowance to the next year. But you can’t save it up any longer, or it will be lost.Gifts of up to £250 per person per financial year to any number of people are exempt (apart from those who may have received part of the £3,000 allowance).Each parent of a bride or groom can give up to £5,000 (a nasty little catch for many in middle England); grandparents or other relatives can give up to £2,500 and anyone else can give £1,000.Gifts to registered charities and approved political parties are also exempt from IHT.
The Best Ways to Avoid IHT Legally
- Take advantage of the many IHT-exempt investments available – but bear in mind they are rarely low risk and every penny might be lost.
- If you have more money left at the end of each month than you did the month before, on a consistent basis, then Gifts out of Normal Income should be considered – but they should be consistent, and your executors will need you to keep records of gifts, and of your income and expenditure.
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