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If you’re planning on passing money or assets to your loved ones when you’re gone, your heirs could face inheritance tax bill bigger than ever before. According to the Office for Budget Responsibility, families will pay an extra £900 million in inheritance tax over the next five years.
But what does inheritance tax actually mean? Who is responsible? And how can you gift money without being taxed? Ellis Bates answer some common questions on the inheritance tax threshold, including how your family may be liable.
Inheritance Tax (IHT) is the tax that your beneficiaries may have to pay if your estate (or everything you own) exceeds a certain amount. Inheritance tax is usually a one-off payment, due after your death. It’s payable on all assets you owned during your lifetime, unless there is the benefit of any relief such as business property or agricultural relief.
The current basic inheritance tax threshold is £325,000 for an individual. If the value of your estate exceeds this amount and does not have the benefit of any tax reliefs, inheritance tax will be payable at 40% on the amount that exceeds the threshold. So, for example, if your assets and savings add up to £500,000, the inheritance tax bill will be paid on £175,000 (£500,000 – £325,000). At 40%, that adds up to a bill of £70,000 to the Government – if you haven’t been savvy with your arrangements, that is!
The threshold can be transferred to the estate of a surviving spouse. So, a married couple or civil partner benefits from a combined basic inheritance tax threshold of £650,000. (Which means, in the example above, if your assets and savings add up to £500,000, no IHT needs to be paid).
The Government chose to introduce a complex piece of legislation called the Residential Nil Rate Band (RNRB) as of 6th April 2017. This is available for residences inherited by direct descendants in addition to the existing nil rate band (NRB).
If the value of your estate is above the nil rate band (NRB), then the part of your estate that is above this threshold will be liable for tax at the rate of 40%. This means that larger estates can incur a large bill.
The residential nil rate band (RNRB) currently adds a further £150,000 to the NRB. This will then increase by £25,000 next year (2020/21) to £175,000. Each person will therefore have a maximum allowance of £500,000, with surviving spouses potentially having an allowance of £1 million.
Should you pass a property onto your spouse or civil partner when you die, there is no inheritance tax to pay. However, leaving a property to another person – including children or grandchildren – in your will counts towards the value of your estate.
In addition, if your child has lived with you as a tenant before you die – and has paid you rent, or has evidence that they pay some bills – your property may be exempt from IHT. Speak to a financial advisor for more in-depth help about this.
Any money gifted more than seven years before you die doesn’t fall under IHT. You can also make up to £3,000 worth of gifts in any tax year to relatives without incurring a IHT charge. This allowance carries through to the next year if you haven’t used the previous year’s allowance. You can give as many gifts of £250 or less to unrelated friends as you like each year.
You can also gift one-off payments to your children up to £5,000 and £2,500 to grandchildren for life events, like getting married.
Be very careful, however, about giving money away if you’re planning to move into long-term residential care soon. Giving away lots of money before you move is ‘deprivation of capital’ and that affects your entitlement to state help for your (or your spouse’s) care.
The most common method of paying inheritance tax is from the estate – or everything you own minus mortgage debt, and funeral expenses. However, if the tax is due on the gifts you made during the last seven years of your life, the people who receive the gifts must pay the amount due.
The only time inheritance tax is paid at all is if your estate (that’s your property, belongings, cars, other houses, stocks and shares – everything you own) adds up to more than the inheritance tax threshold.
The RNRB differs from the NRB in that it doesn’t apply to lifetime transfers, such as transfers into trusts or gifts given by an individual within a period of seven years before they died. This means that whilst the NRB could potentially be consumed through gift-giving in the last seven years of a person’s life, the RNRB would still be fully available.
There are various ways in which you can avoid paying inheritance tax.
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. If you die intestate (without a will), you can’t control who gets your money. So, if your only living family is your long-lost auntie you never speak to, but you want to leave it all to your best friend, make a will!
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.
Asset transfers between spouses and civil partners are exempt from IHT. Whatever your partner inherits from you is tax-free. This doesn’t count if you’re only co-habiting, though: they must be a registered civil partner or spouse.
Why wait to leave your loved ones financial help until you die? Giving them money now means you get to enjoy it with them! You could also spend your cash in other ways – such as taking your family on a holiday-of-a-lifetime to create memories they’ll hold forever. This way, you all benefit, and the tax man won’t grab your hard-earned (already-paid-tax-on-when-you-earned-it) money.
If you have surplus in your estate, considering leaving a legacy in your will to a favourite charity or two. 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.
Shares listed on the Alternative Investment Market get 100% IHT relief if the money is held in the shares for more than two years. The AIM is where most small companies first list shares, before transferring to the FTSE stock market when they’re more established.
AIM companies are unquoted, meaning they receive 100% IHT relief. Some aren’t unquoted though – specifically, those that are for investment companies and ones investing in property for rental yields. Make sure you’re investing in the right shares by speaking to an independent financial adviser first. Go to Unbiased for local financial advisers and the Chartered Institute of Taxation (CIT) for tax advisers.
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.
The most common set up is this: you pay 20% IHT on assets over your £325,000 limit when you pay into the trust. Then every 10 years, the value of the trust is re-evaluated and you pay 6% tax. Finally, when you die and the assets are taken from the trust, a further 6% is paid. So, if you put assets into the trust, live 12 years, then your trustees inherit, it’s a total of 32% tax paid instead of 40%.
Trusts are useful in situations such as remarriage, as your spouse can continue to benefit from the income of assets (such as rental properties) without being able to sell the assets themselves. If you want to leave your children from your first marriage a protected inheritance, this is one way to do so. Or, you can set up a trust where the trustees decide how the assets and money are split. So, if you make your children the trustees and grandchildren beneficiaries of the trust, your children decide how the money is divided.
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).
Although the threshold remains steady, the property market is continuing to rise. This means that many families will continue to face larger inheritance tax payments. Those in the south of England, where property prices have risen dramatically over the past 20 years, will undoubtedly feel ensnared by the 40 per cent charge.
Making sure your will is up to date and tax efficient, you can maximise the amount loved ones may receive. However, as each person’s circumstances can greatly differ, it’s important to seek professional guidance on all inheritance tax matters. Ensure you are taking all the steps you need to minimise your inheritance tax bill after you pass.