What is inheritance tax?
If your estate is worth more than £325.000 (Nil Rate Band for a single individual) or
£650,000 (Nil Rate Band for married couples/civil partnerships) your beneficiaries will be taxed at 40% on anything above that figure. Your estate is made up of:
cash assets shares, the value of your property and its contents, your car(s), life insurance policies, you may have property that you may own in any part of the world - basically, everything you own. For many people, the taxman's bite of this apple is a little too large to swallow. A new allowance - also called the Residence Nil Rate Band (RNRB) - applies to residential property when it is left to direct descendants. It has resulted in an additional £175.000 of Nil Rate Band from tax year 2018/19, rising to an additional £175.000 in 2020/21.
Who has to pay?
All United Kingdom residents (deemed domiciled for
IHT) are subject to IHT on all worldwide assets above their Nil Rate Band (NRB) allowance. As a general rule, if you have lived in the United Kingdom for 15 years or more within a 20-year period, then you are deemed to be domiciled.
What happens when I die?
If your estate is subject to IHT, the tax bill must normally be paid before probate can be granted. Probate is the process of legally establishing the validity of a will before a judicial authority, and until this has been granted, your assets cannot be released to your beneficiaries. Your executors are legally responsible for administering the estate and therefore responsible for paying the IHT bill. Your executors have six months (from the end of the month in which death occurred) to pay the tax. Payments can be from any savings or investments that may be available within the estate. If the main assets are made up of property and savings or investments (as is typical) and are not available, then you may be able to pay the tax owed in instalments. You can get help, but the trick is knowing who to ask for financial advice. Some advisers fear raising the subject with their clients due to the potential complexity of the matter, sadly resulting in more of your money being paid to Her Majesty's Revenue & Customs and less to your loved ones. Planning doesn't have to be complex - with the proper steps taken your estate can be distributed in the most cost-effective way.
What are my assets?
As mentioned above, your assets consist of everything you own, however, there tends to be some confusion on assets that you have gifted. So, let's take a quick look at the rules regarding gifts. "Gift With Reservation" rules mean that if you gift an asset, you can no longer benefit from it. For example, if you gift the house that you live into your children, you can still live there but will have to pay them rent for living in what is now their house. In turn, they will now have to pay income tax on the rent they receive from you. This may be a solution for you, but you will have to calculate how much income tax will be paid on the rent versus IHT, to see if it is worth it. The same applies if you make use of any asset. In short, if you enjoy the benefit, then you will be taxed as if it is part of your estate. You may have a second property which could be more practical to gift. Don't forget - for it to work, you have to give up all rights to it. For instance, you could gift your holiday home, but you could not use it anymore, or if you did, you would have to pay for the privilege. However, after the third year of the gift being made, it is subject to taper relief - a sliding scale of tax reduction
that occurs from the third to the seventh year (see chart below).
It is important to note how the taper relief is applied.
How do I plan ahead?
The first thing to do is to make a will. In your Will, you can make provisions for some of your allowable transfers to ensure that they are not wasted, like the £3,000 annual exemption. If you are married or in a civil partnership, this could amount to £6,000, saving £2,400 straight away! Next would be to ensure you don't lose your Transferable Nil Rate Band (TNRB). On the 9th of October 2007, TNRB was introduced. Married couples and civil partners can transfer any unused NRB from the first deceased partner's NRB, regardless of when death occurred. This means planning can be quite straightforward in most cases, but there are a couple of things to bear in mind. Firstly, the TNRB is not automatic - the executors of your estate have to make a claim on your behalf. However, if you have used
some of your NRB in your will, they can only use the balance.
For example, if you state in your will you wish to leave your children £130,000, this means you will have used up some of your £325,000 NRB. This amount would equate to 40% of your NRB. So, if on second death - let's assume that the NRB is now £400,000 - then there will only be 60% of the TNRB available. Had nothing been gifted to children on first death then the whole TNRB would be available, which would potentially mean a tax saving on second death. We say potentially, as historically the NRB has been increased by
the government year on year, but recently we have seen it frozen. One would assume that we will see this yearly increase reinstated in the future, so it's not bad planning to simply leave everything to your surviving spouse or civil partner, thus maximising the amount of TNRB (only, of course, if this suits your wishes).
If you remarry after your partner's death, you are entitled to use your deceased
partner's allowance in the same way. If you have remarried somebody who was also previously widowed, you could pass on up to £1,300,000 to your beneficiaries, free of IHT.
Allowable Transfers
Some assets are exempt from Inheritance Tax if they are transferred, during a person's
lifetime. These include:
Annual Exemption
A transfer of £3.000 can be made each tax year. If the entire £3,000 is not used in any
one tax year, the balance can be carried forward to the next tax year.
Small Gift Exemption
A gift of £250 can be made each tax year to any number of people.
Normal Expenditure out of Income
Gifts of a recurring nature can be made out of income, so long as they do not affect the
donor's (the person making the gift) standard of living.
Marriage Gift Exemption
This is a gift made in consideration of a marriage taking place. From a parent, this can
be up to £5,000, from a grandparent this can be up to £2,500, and from anyone else this
can be up to £1.000.