What is Inheritance Tax (IHT)?
IHT is the tax applied to your estate by HMRC when you die. It is usually calculated and paid during the process of getting a Grant of Probate (where there is a will) or Letters of Administration (where you died ‘intestate’, which means without a will) in order to administer the estate. Not all estates will be subject to IHT.
How is it calculated?
When you die, your executors or administrators may have to report to HMRC the gross and net values of your estate in order to get a Grant if they need to administer your estate. To do this, they need a list of the date of death values of all of your assets, like residential and commercial properties, companies, banks and building society accounts, investments, shares, life policies and other financial products, and liabilities, like mortgages, care fees and credit cards/loans.
If the net estate exceeds the Nil Rate Band threshold, which currently stands at £325,000, IHT at 40% will be payable on the amount above that figure.
The Nil Rate Band threshold (NRB)
This is the upper amount that you are allowed to leave in your estate on death before it is subject to IHT. It is so-called because up to £325,000, there is no IHT to pay.
Do things change if I am married?
Yes - any assets left to a spouse or civil partner are exempt from IHT when the first spouse or civil partner dies. In addition, if you die first and leave your whole estate to your spouse or civil partner, your NRB of £325,000 rolls over to them (otherwise known as the transferrable NRB). On death, the regulations permit two NRBs for the estate, which means it can be up to £650,000 before IHT is payable.
Residence Nil Rate Band (RNRB)
If you leave your main residence to your children or grandchildren (you can either leave them your home as a specific gift in your Will or it can form part of the residue of your estate), your estate could also benefit from RNRB. This is an additional £175,000 on top of your basic NRB of £325,000, meaning your estate could be up to £500,000 when you die before IHT is payable.
More good news for married couples or civil partners. As with NRBs, RNRBs are also transferrable so if you die and leave everything to your spouse or civil partner and there is a family house which is ultimately left to your children or grandchildren, your RNRB of £175,000 is also transferred to the survivor.
This means that with astute personal finance planning, a married couple or civil partners who leave everything to each other and ultimately the family home to their children or grandchildren could have an estate of up to £1,000,000 when the survivor dies before IHT is payable.
Can the IHT bill be reduced in any other way?
The Seven Year Rule
Any money given away before you die may be regarded as being part of your estate and therefore liable to IHT if your death occurs within seven years of having made the gift. So, as life expectancy is not an exact science, giving gifts sooner is recommended.
The recipient pays the IHT on lifetime gifting
It is important to note that IHT on lifetime gifting is also payable by the beneficiary of the gift, not the estate. If you make large lifetime gifts, the beneficiaries could take out life insurance against the potential IHT bill.
Gifts in trust
Most gifts in trust are now subject to IHT even if made during your lifetime, but this is an area where you would need specialist advice. Also consider that HMRC requires transparency, so most trusts need to be registered now on their online Trust Registration Service (TRS) and there are penalties for not doing so.
There are a range of other exemptions permitted under the regulations surrounding gifting worth taking into account to help lessen the tax bill:
- Annual IHT gift exemption: the first £3,000 given away to one person every year is not subject to IHT and it can be carried forward to the following year if not all used in one go.
- Gifts to charities and political parties are IHT free.
- Also free of IHT are multiple gifts of no more than £250 to any one recipient per tax year.
- Gifts from income: if you have income and you give money regularly from that, leaving you enough not to impact on your lifestyle, then this is also exempt from IHT.
- Gifts on consideration of marriage: gifts are also exempt from IHT if they are conditional on an agreement of marriage or civil partnership, though the maximum that can be spent this way is £5,000 from a parent and less from others.
There are a range of valuable reliefs to legitimately reduce your estate’s tax bill if you plan carefully. Below are the main reliefs available.
Any part of your estate including your house you leave to charity when you die is exempt from IHT. On top of that, if you leave at least 10% of your estate to charity, if the rest of your estate is above the NRBs available to it, a reduced rate of IHT is applied to it of 36%.
Agricultural Property Relief (APR)
If you own agricultural property that is part of a working farm, a percentage may be exempt from tax (50 or 100%), making this a very valuable relief.
Similarly, if you own woodland, those who inherit it as part of your estate when you die can apply for the timber/trees in it, but not the land itself, to be deemed IHT exempt.
Heritage Asset Relief
Some buildings, land and objects can be exempt from IHT if left to a beneficiary and they agree to look after them, make them available to the public and keep them in the UK.
Business Relief (BR)
If you have a business or company which forms part of your estate when you die, BR may be available on the business itself and its assets so that 50% or 100% of the value of the corporate entity is not taxable. If you own shares in certain corporate businesses as part of an investment (e.g. an Enterprise Investment Scheme or EIS), these may also be subject to BR
As you can see, lifetime gifting and reliefs can be very useful but there are a range of rules and conditions for them to be applicable, including when you made a gift or how long you have owned an asset, and for that reason, expert advice from a solicitor, independent financial adviser and accountant is always advisable.