Inheritance tax is paid on the total value of someone’s estate when they die. It’s also sometimes payable on trusts and gifts made during that person’s lifetime. However you only pay a certain amount if the total estate value is over the inheritance tax threshold and then you only pay tax on what is over the set limit.
Firstly don’t panic – not everyone has to pay inheritance tax. It’s only applicable if assets and any combined wealth are over the current inheritance tax threshold (£325,000). Any wealth you own above this allowed amount, including the proceeds from selling your house, will be taxed at 40% on death, with the main exception being gifts made to your spouse or civil partner. Since October 2007, married couples and registered civil partners can effectively increase the threshold on their estate when the second partner dies – to as much as £650,000.
In most cases, you must pay inheritance tax within six months of the end of the month in which the deceased died. Be careful as interest is charged on any tax not paid by the due date, no matter what caused the delay in payment. Don’t worry if the majority of the tax would be paid through the value of the estate such as a house because HMRC have kindly developed a system where you can pay yearly instalments over 10 years. Fortunately, there are ways of reducing your potential liability (i.e. the enormous amount of tax your children may have to pay).
You can’t reduce the rate of tax that your inheritors will pay (unless you donate some of your estate to charity then its 36% rather than 40%) but you can make life easier by trying to avoid having your children pay inheritance tax altogether by reducing the value of your assets. One of the most effective, if you can afford it, is to make gifts during your lifetime. Apart from saving money for everyone – and annoying the government in the process which is always a good thing – it means that the people you give to have the chance to say ‘thank you’! Although inheritance tax may become payable on gifts made during your lifetime, in practice most gifts are free of tax, because you can take advantage of various exemptions that are available. These are divided into two categories:
- Immediately exempt transfers and
- Potentially exempt transfers.
Immediately exempt transfers
- Annual gifts of up to £3,000. This amount can be given to one recipient or divided among several each year. If the allowance isn’t used in one year, it can be carried forward to the next year only.
Any number of gifts of up to £250 per recipient per year. It’s important that a recipient doesn’t receive any more than this amount or the exemption will be lost.
- Gifts of any amount which are funded out of your normal spending, provided they don’t reduce your normal standard of living.
- Anything you give your husband or wife, but there is a limit of up to £55,000 if you live in the UK and they are domiciled in another country.
- Gifts for the maintenance of your family, such as for children under 18 or those still in full-time education. There is no specific limit on these gifts.
- Gifts made on marriage. Parents can give £5,000 to each of their children (including adopted children and step children) or the person that their child is marrying. Grandparents can give £2,500 to each grandchild, great grandchild or the person they are marrying. There’s also a £1,000 exemption for financial gifts from friends.
- Gifts to charities and, surprise, surprise, to political parties. Check out the full list here.
Potentially exempt transfers
- Any gifts exceeding the immediately exempt transfer limits would be counted as ‘potentially exempt transfers’. This means that if you live for seven years after the gift is made, they will not be liable to inheritance tax (IHT).
- If you die earlier, any money you’ve given in the past seven years plus the value of your house and assets is all added up. Tax payable on the lot will depend on how long you’ve lived since making the gift. For example, if you die within three years of making the gift, the full amount of any inheritance tax on the gift will be payable. If you die between three and four years later, only 80% of that amount will be due. So keep active and healthy and don’t let the tax man get your children’s money!
Beat the taxman legally
There are various ways in which you can avoid paying inheritance tax.
- MAKE A WILL! Just do it…go on, you know you want to…well, all right, you don’t really but if you don’t do it, whatever age you are, a large chunk of the money you have will go to the Government in one form or another. For more information on how to go about it and how to do your own will if you’d like to go that route you can read our easy guide for getting a will written here. To find out how you can benefit from writing a will and possibly save £1,000s in tax click here.
- Transfers of assets between spouses and civil partners are exempt from inheritance tax. Anything your husband or wife inherits from you is tax-free, although this is not the case if you just co-habit. Your partner then has to pay tax on anything that didn’t have their name on in the first place.
- Give away as much as you’re allowed to while you’re still alive. It’s much nicer, anyway, to experience your children’s (or your favourite charity’s) gratitude while you can.
- Give as much of your surplus as possible to charity in your will. Better for them to have it than the tax man. Go to Rememberacharity for more information on how to do this. You can also pay a reduce rate of 36% inheritance tax if anything is left to charity.
- Invest in AIM-listed shares. AIM is the Alternative Investment Market and is like a FTSE index for small companies. Many small companies start on the AIM market and then transfer to the FTSE when they ‘grow up’. Some AIM-listed companies can do very well indeed but because the companies are small it can be very volatile and you can
lose a lot if you’re unlucky with your investment. However, most AIM companies are what is called ‘unquoted’ and, as there’s an odd little IHT rule that says that any assets held in an unquoted company qualifies for 100% IHT relief after the money’s been there for over two years, tax planners have become rather excited about it. It isn’t easy to work out which companies are unquoted and which aren’t. The Revenue doesn’t provide a list of them, helpfully, and just suggests that you seek advice from a tax accountant or financial adviser (and hope that they know – they don’t always!) Go to Unbiased for local financial advisers and the Chartered Institute of Taxation (CIT) for tax advisers.
- Set up a trust. This is a written arrangement whereby an appointed trustee is given money or assets to hold and manage on behalf of the person you want to benefit. They’re a useful, if sometimes complex, way of giving money, property or shares to others while ensuring that someone you trust (hence the name) is overseeing them. You can create a trust while you’re alive by a formal trust deed (or ‘settlement’) or you can create one in your will (a ‘will trust’). You will need advice on this so find out about local experts from the Society of Trust & Estate Practitioners (STEP).
Get expert advice
If you have a fair amount of assets or a complex personal situation, it’s best to get proper advice on inheritance tax planning. If your accountant is a specialist in this then speak to him or her, but most aren’t so it’s best to ask around or look on the STEP Or CIT websites.