Inheritance tax or IHT can be a complex issue. In this helpful guide, we touch on eight things you should know about IHT and ways to mitigate tax payable on an estate.
Will I have to pay inheritance tax?
Whether or not you need to pay inheritance tax (IHT) will depend on the size of the estate left behind. If the estate’s total value, including any gifts made in the previous seven years, does not exceed £325,000, then there will be no IHT to pay.
If the deceased leaves their main residential home to a direct descendant, there is a further nil band rate of up to £175,000 available.
All this considered, an individual can be worth up to £500k before their estate is subject to inheritance tax. And the impact of an IHT liability on beneficiaries can be significant.
For beneficiaries (usually the deceased’s children), a large amount of their inheritance could be liable to inheritance tax at a rate of 40%. But with a bit of planning, donors can do a lot to help mitigate this IHT before death. For instance, it’s important to note that gifts to UK resident and domiciled spouses on passing are not subject to IHT.
How much will I have to pay?
“How much will I have to pay” is one of the biggest questions we often get on the subject of inheritance tax.
While this is difficult to assess upfront (each case is very different depending on an individual’s circumstances), there are around four broad thresholds we can refer to for illustration.
Even within these, the answer will still vary depending on whether or not a primary residence is left to a direct descendant. The following table provides a rough idea of what descendants can expect to pay in IHT once they’ve passed a certain threshold of wealth or accumulated assets.*
It’s important to note that the IHT payments are the same after the £3m threshold, regardless of whether a main residence is left to a direct descendant as the £175k allowance is tapered after an estate is worth more than £2m.
|Estate worth £500k||Estate worth £1m||Estate worth £2m||Estate worth £3m**|
|Main residence is left to a direct descendant||nil||£200,000||£600,000||£1,070,000|
|Main residence is not left to any direct descendant||£70,000||£270,000||£670,000||£1,070,000|
*Please note: figures are for illustrative purposes only; actual figures will vary as every individual’s case is different
**The £175k allowance is tapered after an estate exceeds £2m
Lifetime potentially exempt transfers
As we mentioned at the beginning of this article, a few things can be done to mitigate the impact of inheritance tax. One way is for the donor to make gifts to individuals during their lifetime.
These transfers are potentially exempt from IHT if the donor survives the gift by seven years. In this case, it falls out of the estate for IHT purposes.
However, if the donor dies within seven years, then some IHT may be due depending on how long ago the gift was made.
There may be other tax implications depending on what kind of asset is gifted. For example, the gift of a house may trigger a capital gains tax liability.
Gifts out of excess income
If the donor provides gifts out of excess income, these can be exempt from inheritance tax. The donor would need to be sure that they are making the gift out of income that is genuinely more than they need to maintain their current standard of living.
It is useful to review an estate and IHT allowances each year to manage and/or curtail any excess growth that would lead to an overall increase in IHT liability for beneficiaries.
Gifts into trusts
Another way to help mitigate IHT is through the establishment of trusts for beneficiaries. Trusts are a good way to protect assets and offer younger generations a way to benefit from income without having direct access to assets gifted.
Trusts are a particularly useful tool for grandparents looking to make gifts. That being said, they can also be used for asset protection when gifting to adult children who are either too young to own the asset outright or to provide protection against possible future divorce within a family (though it’s crucial to note that not all trusts provide effective protection against divorce).
It’s worth noting that any transfer into a trust is chargeable and can incur an immediate 20% charge if the value transferred into the trust exceeds the available nil rate band (up to £325,000).
Business property relief
Inheritance tax can also be reduced if a family owns a trading company.
Individuals who own shares in a private trading company can reduce their IHT liability if shares are held for two years. This provides helpful relief for beneficiaries.
In fact, 100% of a company’s value can be protected from IHT, providing there are only trading assets within the company.
In this case, AIM investments are a useful tool and can significantly reduce IHT exposure. AIM listed companies are classed as private and therefore can attract business property relief if an individual holds shares in an AIM listed trading company.
Political and Charitable donations
Donations left to charity are also exempt from IHT. Donations to charity through a will and/or estate can reduce the rate of IHT charged from 40% to 36% if a sufficient amount is donated.
Finally, there are annual exemptions that can help to reduce IHT liabilities.
Each individual is entitled to a £3,000 annual exemption for inheritance tax gifts in a tax year. The previous year’s exemption can also be used if not done so. These gifts can be to anyone and may save £1,200 per year on the IHT payable. In addition, there are a few other exemptions, including:
A £250 small gifts rule – Up to £250 can be gifted per person each tax year as long as another allowance hasn’t been used for the same person. This exemption is intended to cover small gifts such as for Christmas or birthdays.
Weddings gifts – Wedding gifts to a happy couple can also be tax-efficient and given free of IHT. The exemption amounts are as follows:
- £5,000 gifted to your child
- £2,500 to a grandchild or great-grandchild
- £1,000 to anyone else
These exemptions are per person and therefore a husband and wife can give £5,000 each to their child for a wedding gift.
Regular gifts out of income – These can be regular payments to help with living costs. There’s no limit for these as long as:
- The donor can afford payments after meeting their own living costs
- They make the payments from regular monthly income
Carrying out effective inheritance tax planning early on will help to ensure that your IHT liability will be reduced or even mitigated completely, meaning your loved ones can enjoy the most of their inheritance when you pass away.
The starting point is speaking to an IHT expert and helping them to understand your current position and intentions. At Bracey’s, we offer tailored advice, specific to your circumstances and goals so find out more about what we can do for you. There are a number of personal tax services we offer our clients that might be suitable for your circumstances.
If you would like a review to see if we can identify any planning opportunities available to you, please feel free to get in touch. We offer a free online 30-minute consultation for us to better understand your situation.