Your five-minute guide to inheritance tax planning – part 1

What would you prefer to leave your loved ones: a generous legacy or a gigantic bill? Chartered Financial Planner Michael Roberts returns with another of his highly popular guides to personal taxation – this time explaining the complex world of inheritance tax.

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It might not feel this way, but in recent decades people have been getting wealthier – at least on paper. Asset values – and in particular, property prices – have risen sharply. As a result, more and more people are being caught by inheritance tax (IHT). It is often said that IHT is a ‘voluntary tax, as with proper planning it’s perfectly possible, and legal, to avoid it. And with a potential tax rate of 40 per cent on death, there is plenty of motivation to do just that.

Many complicated schemes exist to help people reduce their IHT liability. However, it is important first to consider the generous reliefs and exemptions available, since for many people this will be enough to solve the problem. In part 1 of this guide, I’ll be covering a few simple strategies for reducing your estate’s exposure to IHT.

Your nil rate band – what is it?

Everyone who is UK domiciled has a ‘nil rate band’ (often written as NRB). This is an amount which a person can leave on death with IHT being charged at zero (i.e. no tax is payable on it at all). The current NRB is £325,000.

The transferrable nil rate band

In the past, unless an individual used their NRB upon death, it was lost. This often used to be the case where, for example, a husband died and left all his assets to his widow. As transfers to spouses are exempt from IHT, this effectively wasted the NRB of the first person to die.

Several years ago the concept of ‘transferrable NRBs’ was introduced, and it made a huge difference. For instance, in the example above, the widow would also inherit any unused portion of her husband’s NRB. This would then allow her to bequeath more to her children without them having to pay IHT.

Example

David and Martha are married. They have a total estate worth £650,000 which is divided equally between them.

When David dies, he leaves all his assets to Martha. Because they were married, this is an exempt transfer – there is no IHT chargeable between UK domiciled spouses or civil partners. David has not left any gifts to anyone else on his death, so he has not used any of his NRB.

Later that year Martha also dies. Her personal representatives can now make a claim to use David’s NRB as well as hers – so the total NRB is 2 x £325,000 = £650,000. This covers the total value of their estate, so no IHT is payable.

In the above example, note how the transferrable NRB must be claimed when the surviving spouse dies; it is not automatically available. Therefore it is important to keep certain documentation following the administration of the first estate, to ensure that this claim is successful.

Exempt gifts

Certain gifts made during someone’s lifetime are exempt from IHT. These include:

Inter-spousal gifts

As mentioned above, any transfer of assets between spouses or civil partners is exempt from IHT, whether made during lifetime or upon death.

Small gifts

You can make a gift of up to £250 to anyone else, free of IHT implications. You can give as many of these gifts as you like, but only one such gift per person in any one tax year – and it must not form part of a larger gift.

Annual exemption

Each tax year you are allowed to make a single larger gift of up to £3,000 without IHT implications. The gift can be to another individual or to a trust, for example. You can carry forward this allowance (called the Annual Exemption) for up to one year – so if you didn’t use this allowance last year, you can make a gift of up to £6,000 this year without IHT implications.

Wedding gifts

You can make gifts to people on the occasion of their marriage as follows, without IHT implications:

  • Parents can each give cash or gifts of up to £5,000
  • Grandparents and great grandparents can each give up to £2,500
  • Anyone else can give up to £1,000

Payments or gifts from normal expenditure

You are also allowed to make regular payments or gifts from your income without IHT implications. This can be an extremely useful planning tool. However, there are a number of rules to consider:

  • The payments must be made from after-tax income
  • The payments must not be made from capital
  • You must have sufficient income after making the gifts to maintain your lifestyle (in other words it must be ‘spare’ income
  • There should normally be a regular pattern to these gifts

These payments could include, for example, regular gifts for Christmas or birthdays, regular premiums on a life insurance policy, or regular payments to a family member or friend to help with their cost of living.

Charitable gifts

You can make gifts to certain organisations free from IHT implications. These may include:

  • Qualifying charities established in the EU or another permitted country
  • Some institutions, for example the National Trust
  • Certain political parties

Making a charitable gift through your will can also reduce the rate of tax that applies to your taxable estate to 36 per cent, provided that you meet certain qualifying criteria.

That’s it for part 1. In part 2, we will take a look at some of the more complex areas of IHT planning, where the tax may or may not apply – making it even more important to seek professional advice before taking action.

In the meantime, talk to your financial adviser about your plans for your estate and see if IHT planning could help your beneficiaries when the time comes.

You can search for an adviser near you using the smart postcode search on Unbiased.

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About the authorProtectInvest

Michael Roberts is a Chartered Financial Planner with Protect and Invest Ltd, a small firm based in Newbury and covering the Thames Valley. They specialise in retirement planning, investments and estate planning.

Important note: This article is for information purposes only and should not be considered to be a recommendation. This article is based on our understanding of current and draft pension and tax rules on the date of this article. Please note that tax and pension rules are subject to change; if you are at all uncertain about the suitability of any option for your circumstances you should seek regulated personal financial advice. You should not take action solely on the basis of this article without seeking advice specific to your circumstances.