Around 30,000 estates were subject to Inheritance Tax (IHT) during the 2016-17 tax year – a rise of 11,000 in just three years, driven mainly by the rapid rise in nationwide house prices.
IHT receipts rose by 23% in the first quarter of 2017, compared to the previous year, so this is a timely opportunity to examine how the Government taxes what you leave behind – and what you can do to minimise the impact on your beneficiaries.
Inheritance Tax Basics
You won’t be required to pay IHT if your estate is valued at less than £325,000 (the ‘nil rate band’), or if you choose to leave all of your estate to your civil partner or spouse, a community amateur sports club or a charity.
The current threshold has been in place since 2009 and has not risen with inflation.
The standard rate of IHT is 40% on the value of estates falling above this threshold.
As an example, if an estate is valued at £500,000, subject to the standard individual nil-rate band, then £175,000 of the estate will be liable for tax.
It may be possible for this 40% to be reduced to 36% on some of your assets if it is found that you have left 10% or more of your ‘net value’ to a charity within your will.
New Residence Nil Rate Band
From April 2017, a new Residence Nil Rate Band (RNRB) was introduced, which provides additional relief in addition to the existing nil-rate band.
This allows for the first £100,000 of a home’s value to be IHT exempt, as long as it passed to a ‘direct descendant’. This threshold rises by £25,000 each year until it reaches £175,000 during the 2020/21 tax year
The rules which govern the RNRB are, unsurprisingly, complex. However, should you leave eligible property (or the proceeds of a property you have owned previously) to eligible beneficiaries, the first £425,000 of your estate will be free from IHT during 2017/18.
If one spouse passes away and leaves everything to their partner, the surviving spouse also inherits their partner’s IHT allowances, so theoretically the first £850,000 of the couple’s combined estate could be tax-free.
By 2020/21, estates worth up to £1,000,000 could be tax-free, if a number of conditions are met.
Significantly, 95% of estates remain unaffected by IHT, despite the recent rise in those caught by the taxman.
Reliefs and Exemptions
As with other types of tax, there are many exemptions and reliefs from Inheritance Tax.
The way gifts you make during your lifetime are treated will typically depend on timing, as well as the amounts involved.
Aside from various fixed exemptions which we explain below, gifts made within the 7 years before you die will usually be re-included within your estate when it comes to assessing your IHT bill.
Significant gifts (of cash, property or other assets) made within 7 years are subject to ‘taper relief’ – with the rate of IHT reducing by 8% per year from the start of the 4th year, to zero after 7 years have elapsed.
If you gift your home to someone in order to avoid inheritance tax, they will still be liable to pay this if you die within seven years of gifting it.
You should be aware of ‘gifts with reservation’, which many people fail to read up on. An elderly parent may sign over their property to a child, but continue living in the property. In this case, the value of the property remains in the parent’s estate, as they are still benefiting from it.
Typically there is no tax liability on small gifts made from your normal income – i.e. birthday gifts. You can gift up to £250 per person, provided you haven’t already used any other exemption on this person. You also don’t need to pay any tax on gifts made to your spouse or partner, provided they live in the UK permanently.
In each tax year, you are able to gift up to £3,000 tax-free. This is referred to as ‘annual exemption’ and can be carried forward to the next year, but only for one year.
You can give away wedding gifts up to £1,000 per person, increasing to £5,000 for a child or £2,500 for either grandchildren or great-grandchildren. You can also gift charities and political parties.
You should seek professional advice before relying on anything mentioned in this article. You should also consider hiring a specialist to write your will, as many people think (incorrectly) that 100% of their assets will automatically be passed on to their partners in the absence of a will. This isn’t always the case.
Here are some useful resources elsewhere on the web which explain this complex topic in an accessible way:
- The Government’s simple guides to IHT
- Which? guide to IHT tax planning and taper relief
- Money Advice Service – 5 ways to limit your IHT liability
- Tax-efficient protection for contractors - life insurance and income protection - your company pays the premiums.
- Need a new accountant? - compare 30+ specialist firms
- Switch between umbrella and limited - flexible solution from Nixon Williams for contractors who may be affected by the Off-Payroll changes.