Quick Guide to Inheritance Tax
Inheritance Tax (IHT) is paid on the estate of someone who’s died. It has been labelled “Britain’s most hated tax” and the number of people paying is growing.
This article provides a brief overview of the key facts, including some tips on how good Estate Planning can help avoid overpaying IHT. You should seek proper advice before making any decisions on estate planning.
Who pays and when?
The person dealing with a deceased person’s estate will pay IHT to HM Revenue and Customs (HMRC) using funds from the Estate (property, money and possessions). If there is a Will, this person is usually termed the Executor, otherwise the person managing the estate, including paying any IHT due, is called an Administrator.
HMRC expects IHT due to be paid by the end of the sixth month after the person’s death. After that, HMRC may charge interest on the tax owed. This can cause issues for Executors and Administrators because it is not always possible to sell the assets within six months.
If the deceased person advanced gifts in the last seven years of their life, the people who received those gifts may be liable to pay IHT. Whether IHT is due and how much depends on the amount gifted and when it was gifted.
As of writing, the standard IHT rate is 40%. This is charged on the part of the estate above any applicable tax-free allowance thresholds. The standard tax-free allowance for IHT is known as the Nil Rate Band (NRB) and is currently £325,000.
When the deceased is giving away their home to their children or grandchildren, they may also qualify for an additional allowance called the Residence Nil Rate Band (RNRB) (currently £175,000), increasing the threshold to £500,000 as of the time of writing.
Reliefs and exemptions
There are some additional reliefs and exemptions from IHT available. The most used and useful is spouse or civil partner exemption which means, in general, gifting to a spouse or civil partner is free from IHT and does not use up one’s tax-free allowance. Further, any unused allowance can also be transferred to the surviving spouse/civil partner to be used on their death. Note that spouse/civil partner does not include “common law” wives or husbands.
Unknown to many, although any gifts given more than seven years before death are excluded from the estate for IHT purposes, gifts given less than seven years prior to death might be included in the estate for IHT purposes. Gifts given less than seven years before death will usually be taxed but at a reduced rate (known as taper relief).
Some gifts given whilst the donor is still alive may escape IHT entirely. These include an annual exemption of £3,000 per year, a wedding gift of between £1,000 and £5,000 (depending on who it is given to) and regular gifts out of any ‘surplus income’. Gifts to charity, political parties and some other qualifying clubs are also exempt from IHT.
Other reliefs such as Business Relief and Agricultural Relief allow some assets to be passed on free of IHT, or with a reduced rate. The rules governing such assets are complex and should be considered alongside professional advice.
How to reduce your IHT bill
The best way to minimise your IHT bill is to understand the rules, allowances, lifetime gifts, exemptions and reliefs and use them to your advantage. Get expert advice from an Estate Planner on how Wills, Trusts and lifetime gifting and Inheritance Tax planning can help.
As stated above, gifts to charity are free from IHT. Such bequests can also help your IHT liability on other gifts: if 10% or more of the net estate is gifted to charity, the IHT rate due on the taxable estate is reduced from 40% to 36%.
Putting assets into a trust to be used for the benefit of your beneficiaries can protect those assets and help reduce your IHT bill. Trusts have been used for hundreds of years and are powerful tools for Estate Planning. Find out more about Trusts here.
Some investments can be passed outside of your estate so that they avoid IHT altogether. These include most pensions, life assurance policy or IHT exempt investments such as unlisted shares including private limited companies and shares in AIM-listed companies (subject to qualifying conditions).