What is Inheritance Tax & Does It Apply To Me?
30 June 2017 by Amy Burton
What is Inheritance Tax (IHT)?
IHT is a potential tax liability that is calculated when you die. It is something that can also apply to certain transactions during your lifetime, so it is important to be aware of what your individual IHT situation is. If you choose not to assess your situation and it indeed proves to be relevant to your estate, it can prove to be very traumatic and burdensome for your family and friends when you pass away.
Who has to pay IHT?
Generally speaking, everyone is potentially liable to pay IHT. For an individual the starting point, when they die or when assessing whether they have a liability, is to firstly look at whether they fall below the thresholds for IHT. If they do, then there is no IHT to pay, but if they don’t then we have to look at whether there are other options or lifetime planning that can be undertaken to reduce that liability.
Who doesn’t have to pay IHT?
Registered charities are exempt from paying IHT on any amount left to them from someone’s estate. This is to encourage people to leave gifts or legacies in their Wills for the benefit of charities. Many charities rely largely on such legacies as a main source of their funding.
Married couples or civil partners are also exempt from paying IHT when assets pass between them. For example, when one partner dies, absolutely everything that passes to the survivor will be free of IHT.
Gifts passing to certain political parties, heritage funds, for example the National Trust, and certain museums are amongst the more specific class of exempt beneficiaries too.
How much is IHT?
Every individual has their own IHT ‘allowance’ called the Nil Rate Band. This is the value of assets that are taxed at 0% when someone dies. At the moment this amount is set at £325,000. Subject to other allowances, the IHT rate is 40%.
This means that when you die, all of your assets (including everything from property and cash, to vehicles and personal possessions) will be added up and if the total is under £325,000 then there will be no IHT to pay (assuming they haven’t made any lifetime gifts within the last seven years – see below for further on this point).
If the total is over £325,000 and they are not assets which are passing to one of the exempt beneficiaries (as mentioned above) then we next have to assess whether there are any further allowances that can claimed.
In April of this year the Government introduced a further IHT allowance that could be claimed if someone dies leaving a property that is being left to a ‘direct descendant’ (e.g. children and grandchildren). This additional allowance, called the Residence Nil Rate Band, was introduced at £100,000 and will rise year-on-year until the tax year 2020/21 when it will be £175,000.
If you are eligible for this extra allowance, then this can be claimed on top of your standard IHT allowance.
If you are not eligible for this extra allowance, or the total of your estate still exceeds both of these allowances added together, then potentially IHT will be payable.
IHT is only payable on the excess over and above the allowances – not on the whole amount. So if a total estate (where the RNRB was not available and the assets were not passing to exempt beneficiaries) was £500,000 then 40% IHT would only be chargeable against £175,000 – being £500,000 less the allowance of £325,000. So the IHT would be £70,000.
What happens to my IHT allowance when I die?
If you are single when you die, your IHT allowance dies with you. If you have not used up all of your allowance, it cannot pass on to anyone else.
If you are married or in a civil partnership the rules differ slightly. Subject to certain conditions, your allowance can transfer to your partner upon your death if you have left all of your assets to them. This means that when they die, they will effectively have two allowances to claim – which on current figures would be £650,000.
Unfortunately these rules do not apply to couples who are co-habiting, you must either be married or in a civil partnership at the date of your death.
What can I do to reduce my IHT liability?
Some argue that IHT is an ‘optional tax’ in so far that it is something that potentially can be completely avoided, with the right planning in place.
Lord Jenkins once famously said that IHT “is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”.
We will discuss your IHT situation with you when you visit us to prepare Wills, or if you have made an appointment specifically to discuss your IHT position.
Whilst the amount of IHT planning that can be done within Wills is limited, there are a number of options that we can pursue to help minimize any liability to IHT. Each case will be different and will depend upon the composition of your family group, your wishes and the assets you own, so it is impossible to generalise a way in which we can reduce your IHT liability. In any event, if we think there might be alternative options to help minimise your IHT liability, then we will discuss with you how you can pursue this further.
There are however a number of simple exemptions that are important to remember, which will apply to any gifts that you make during your lifetime, to mitigate your liability to IHT upon your death:
- Each tax year you have an annual exemption of £3,000. This means that you can give away one amount of £3,000 without there being any repercussions from an IHT perspective. For example, to reduce the size of your estate you may decide to give your child £3,000 every tax year – but remember if you have more than one child, it is not £3,000 per child that you can give away, it must be shared.
- There is an exemption called ‘normal expenditure out of income’. The rules are quite complex so if you plan to utilise this exemption, we would recommend that you speak to us or your financial adviser. The key is that if you regularly make gifts out of your surplus income, then any such gifts will not be retrospectively looked at by HMRC when they are calculating the amount of IHT payable. You must be able to show that even after making these gifts, you can still lead the life you are accustomed to (i.e you must not be leaving yourself short of funds).
One example of this would be to pay a grandchild’s school fees, or dance lesson fees, regularly every month. Even a payment to a child without any specific purpose could fit the criteria, as long as there was some pattern of regularity to the gifts.
- Small gifts, under the amount of £250, can also be exempt – for example, birthday or Christmas presents. If the gift is over £250 however, then the exemption cannot be used at all; the total value of the gift must be £250 or under.
- Gifts on the occasion of a marriage or civil partnership can also be exempt, depending on your relationship to the couple.
If your child is getting married, then each parent can give £5,000.
If it is your grandchild getting married, then each grandparent can give £2,500.
Either of the couple can give £2,500 to each other.
Any other person can give £1,000.
To be effective from an IHT perspective, these gifts can be made to either of the couple or to them jointly. The gift must take place on or before the date of the ceremony (provided the ceremony does go ahead). You cannot make the gift after the date of the ceremony.
What is the Seven Year Rule?
Many people have heard of the seven year rule when it comes to IHT. This ‘rule’ applies to any gifts that you make during your lifetime that do not fall within any of the exemptions above (and is usually the case if the gift is over £3,000). When you make such a gift, it starts off a seven year ‘timer’. If you die within seven years of the date of the gift, then all or some of the value of the gift (depending on how long you lived for) will be included in your IHT calculations and tax might be payable in respect of that gift.
If you survive seven years then HMRC can no longer argue that IHT must be paid on any aspect of that gift.
The reasoning behind this is to prevent people from gifting away large sums of money, or assets, before their death with the intention of having to pay less IHT.
To put this into an example, if John makes a gift to his daughter in June 2001 of £10,000 then he must survive until at least June 2008 for this amount of money to not be fully or partially included in his IHT calculations upon death.
Can I give my home away to avoid paying IHT?
With very few exceptions, the answer to this question is often a big NO!
If you live in your home and decide to transfer it into the names of your children, grandchildren or any other individuals, but you continue to live there, then HMRC will forevermore still treat you as being the owner of that property for IHT purposes.
This is because such a gift is called a ‘Gift With Reservation of Benefit’. As the name suggests, it means that you have made a gift but retained the benefit, i.e. you are continuing to live there.
This is one of the few circumstances whereby the seven year rule does not apply – so even if you knew you were going to live for a further seven years (which unfortunately none of us have the ability to do anyway), it will not help and the value of the property at the date of your death will still be potentially taxable.
Is it important to review my Will, or prepare a Will, to ensure that I don’t have to pay any unnecessary IHT?
Even if you already have a Will in place, because the law is ever changing (particularly given the big IHT change in April of this year) it is crucial to keep your Will under review.
Unfortunately because of such changes, a Will that was prepared to help mitigate IHT last year, or even pre-April 2017, might now include provisions that will limit the IHT allowances that can be claimed upon your death.
Prior to the last big change to IHT in October 2007, a lot of people would have had Wills prepared containing ‘Nil Rate Band Discretionary Trusts’. These were trusts that were often set up between married couples to ensure that each other’s IHT allowance was not wasted, as it was only post-October 2007 that a married couple could automatically transfer their allowances to each other.
Such trusts can now actually prove to be disadvantageous from an IHT perspective, given the recent changes in April 2017. So if you know you have one of these trusts in your Will, or aren’t sure, then please do get in touch with one of our team members, so that we can review this with you.
We offer a free Will review service all year round, so even if it is a case of coming in to see us for a no-obligation chat, it could make quite the difference as to how much the tax man claims from you when you die.
How do I arrange an appointment with you to discuss this?
To find the contact details for all of our offices, please click here. You can either send us an email or give us a call and we will arrange a meeting with one of our team members in the office of your preference.