What is Inheritance Tax?
The subject of inheritances and death can be a sensitive and often uncomfortable discussion for individuals to have. However emotive the topic can be, it is best to know what inheritance tax (IHT) is and if it applies to you, rather than the burden be left to loved ones should you pass away.
What is Inheritance Tax?
IHT is a tax in the estate of someone who has died, the estate is made up of assets the individual owned such as property, possessions and cash. The estate can deduct certain costs before calculating the IHT due, for example a mortgage, funeral costs and other personal debts. Certain assets are not included in an estate for IHT purposes, such as pension plans and trust assets. The current IHT rate for estates is 40%.
IHT is also due on chargeable lifetime transfers, such as a transfer into a trust. IHT due on lifetime transfers is 20%.
Who needs to pay it?
Funds from an estate are used to pay the IHT due and this will be done by the person dealing with the estate. This will be an executor if a valid will is held.
People who receive a gift may have to pay IHT if the gift was made less than seven years before the transferor’s death.
Chargeable lifetime transfers over the nil rate band of £325,000 will incur an IHT liability and the trustee will be required to pay the tax. The tax on certain assets can be paid in ten annual instalments.
When does it need to be paid by?
IHT usually needs to be paid by the end of the sixth month after someone dies. If this deadline is missed HMRC will charge interest.
Are any gifts exempt from Inheritance Tax?
The following gifts are exempt from IHT:
- Gifts to charity or community sports club
- Gifts between spouses and civil partners
- Gifts to some political parties
- Small gifts of up to £250 to any recipient
- Gifts on marriage up to £5,000 depending on the recipient
- Regular gifts made out of excess income
What is the nil rate band?
A nil rate band threshold is available and only an estate above this amount is taxable. The current nil rate band is £325,000. Gifts made within the previous 7 years will affect the available nil rate band.
A residence nil rate band is available if a home is left to direct descendants (such as children, stepchildren and grandchildren), this is on top of the standard nil rate band. The current residence rate band is £175,000 but this will be tapered if an estate is worth more than £2 million.
Unused nil and residence rate bands by a deceased spouse can be transferred to the surviving spouse to utilise on their death. Therefore, it is possible to have available rate bands of £1 million if your late spouse did not utilise their rate bands as shown in the example below.
Are there any reliefs available?
- If a gift is made less than 7 years before the transferor’s death the IHT rate may be less than 40% as taper relief will apply.
- If assets meet certain conditions, 50% or 100% relief will apply for some assets:
- Business Property Relief for business assets held such as shares, property or machinery but does not include shares in companies mainly dealing in investments.
- Agricultural Property Relief for land or pasture used to grow crops or to rear animals intensively, it also includes farm buildings but does not include livestock or derelict buildings.
- Gifts to charity are exempt from IHT but if at least 10% of the baseline value of the estate is gifted to charity, the 40% IHT rate for the remainder of the estate is also reduced to 36%.
Inheritance Tax Examples
Ms Black leaves an estate worth £600,000 to her cousin.
|Less nil rate band||(£325,000)|
|IHT @ 40%||£110,000|
Mr Brown passed away leaving a home valued at £900,000, cash of £150,000 and other possessions of £50,000. He leaves his home to his children in his will and his late wife did not utilise her nil rate band.
|Total estate value||£1,100,000|
|Less nil rate band||(£650,000)||(£325,000 uplifted by 100% from his late wife)|
|Less residence nil rate band||(£350,000)||(£175,000 uplifted by 100% from his late wife)|
|IHT @ 40%||£40,000|
As you can see from the above examples, being able to utilise reliefs can make a significant difference in the IHT due.
What planning can be done?
- Hold a valid will. A will ensures your estate is distributed how you see fit and without a valid will your estate will be distributed per intestacy rules, which often surprises bereaved family on how it is split.
- IHT insurance. Insurance can be obtained to settle an IHT liability in the event of your death. Our financial planners can work with you to prepare cashflow forecasts to determine future liabilities and affordability when looking at insurances available.
- Give assets away now. Unlike chargeable lifetime transfers, gifts to individuals are potentially exempt from IHT and are only chargeable if you do no survive 7 years after making the gift. Therefore, if you were intending to make a gift on death, and are comfortable with the gift being made earlier, it may be an option to transfer the asset and it will not form part of your death estate if you survive 7 years. Disposals can trigger a Capital Gains Tax liability and so specialist advice is needed. You should also determine whether you require future financial security and can afford to give assets away now.
- Establish a trust. A trust can be created for many reasons but can be a good option should you wish to protect assets in future for example if a future divorce is of a concern or you are giving funds to someone you feel is irresponsible to manage the funds right now. Putting an asset in to a trust will remove the asset from your estate as well as give you control over how to beneficiary of the trust received funds in future.
- Check if assets qualify for reliefs such as Business Property Relief. If an asset does qualify for relief, it is important to check regularly if it still continues to qualify. Alternatively, you may choose to invest in qualifying assets.
- Gift to charity. If at least 10% of the baseline value of the estate is gifted to charity, a lower IHT rate of 36% will apply.
As with most taxes, we would recommend advice is given based on each specific case. The starting point for any conversation involving Inheritance Tax is to look at the current estate and potential IHT due on it. Ask yourself if you are comfortable with the numbers involved and how your loved ones will be able to deal with the estate, tax and admin involved with managing an estate. Are you comfortable with how your estate will be distributed? Inheritance is an emotive subject and difficult conversations can sometimes be necessary but it is best to plan ahead and ensure you are fully aware of the options available to you.
“It’s so important to understand your IHT position and what planning you can do to provide for and/or potentially reduce this.Deborah Trelease, Chartered Financial Planner
My colleagues in Wealth Management and I have worked closely on behalf of many clients with our Private Clients Tax team and their family lawyers, to ensure plans are in place.
We are happy to discuss your own personal circumstances and wishes – everyone’s is unique to them! Planning can give you peace of mind going forwards for your lifetime and beyond.”
How we can help
We are experienced in dealing with estates, both small and complex, and can review your current estate and advise on options available to you, particularly depending on your personal circumstances and express wishes for how your estate is to be passed on. We can work alongside our financial planners to ensure your investments are managed tax efficiently as well as informing you of relevant insurances that may be applicable.
The information above is generic IHT guidance and as the area can be complex, we recommend you contact us to obtain personal advice. Please do not hesitate to contact us at email@example.com should you wish to explore this area further.