Basic Inheritance Tax Planning

What is Inheritance Tax (IHT)?

IHT is basically a “wealth tax” and has been around in one form or another since 1894 when Estate Duty was introduced. From 1975 to 1986 it was known as Capital Transfer Tax. IHT is charged during your lifetime or upon death at either the death rate (40%) or the lifetime rate (20%). Each individual has an allowance to IHT known as the “nil rate band” or NRB, which has been frozen at £325,000. This means that the first £325,000 of net assets within your estate is assessed to IHT at 0%.

There is also a “residence nil rate band” or RNRB available where the deceased leaves property to direct descendants. The RNRB will provide an allowance of £175,000 by tax year 2020/2021. (It is currently £125,000 - tax year 2018/2019 and will be £150,000 in tax year 2019/2020).

Everything above the NRB and RNRB is potentially charged at 40% unless other reliefs or exemptions are available.

How will Inheritance Tax affect your family

The NRB threshold has increased in value since 1986 in line with inflation but since 6 April 2010 has been frozen at £325,000. The RNRB is set to increase in line with inflation following tax year 2020/2021.

If you think that your house, savings and other assets will increase in value by more than the rate of inflation, you could face a growing IHT liability on your death.

Inheritance Tax does not apply if you leave everything to your spouse

If you leave everything to your spouse there is no IHT payable on your death, unless perhaps you are British and he/she is not. Prior to October 2007, your estate would only have access to your own NRB (perhaps reduced by lifetime gifts) with any excess value potentially liable to IHT at 40%. However, a “transferable NRB” was introduced from 9th. October 2007 to allow the unused NRB of a deceased spouse/civil partner to be claimed on the survivor’s later death. So currently a total of £650,000 may be available for some families in addition to a transferable RNRB. If you organise your assets and liabilities carefully during your lifetime, and in your Will, you can reduce your exposure to IHT even more.

What Inheritance Tax exemptions and reliefs are available
Transferable NRB, and Transferable RNRB.

Married couples or civil partners have a combined NRB of £650,000. The family of a widow(er) who remarries may be able to benefit from a trust of the NRB of the deceased, as well as from a double NRB on the death of the second spouse, making three in all.

Business and Agricultural Assets

Certain business assets (such as shares in a trading company or partnership) or agricultural assets (land and buildings used for agriculture) can qualify for either 50% or 100% relief from IHT. These valuable reliefs can easily be lost through change of use, so the assets need identifying during your lifetime and special care taken when making your Will.

Potentially Exempt Transfers (PET)

Provided you live for 7 years from the date of gift, you can give as much as you like to an individual in your lifetime. However such gifts need to be “absolute” and not via a Trust which may trigger a 20% liability on any excess over your NRB. You also have an annual allowance of £3,000, and a small gift exemption of £250 to any number of recipients. Gifts in contemplation of marriage (or civil partnership) ranging from £1,000 to £5,000 are exempt depending upon your relationship to the happy couple.

Regular Expenditure Out of Income

If after paying tax and meeting normal living expenses you still have surplus income, you can make regular gifts of the excess to an individual, a trust or use it to fund a savings product. HM Revenue & Customs (“HMRC”) look for a pattern of giving over at least 3-4 years, without the gifts adversely affecting the standard of your living - this is often overlooked as a relief, and for high earners can be significant.

Pension & Insurance Policies

Policies often pay out large sums. If these policies are written in trust, these should fall outside your estate for IHT. If you cannot place the proceeds in trust, you can “nominate” to pay these funds elsewhere, this includes death-in-service policies through your work.

Are trusts worth considering

Trusts are not tax efficient in themselves, but they are a useful mechanism for setting aside assets until a beneficiary is older, or you are uncertain whom you wish to benefit eventually . Following the Finance Act 2006, trusts worth more than the NRB will be subject to a reduced rate of IHT every 10 years at 6% on the excess over the NRB.

Trusts can be a useful planning tool and provide tax efficiency in certain circumstances.

We can provide further details regarding the use of trusts in lifetime IHT planning.

What is Pre-Owned Assets Tax (POAT) and do you have to pay it

POAT was a new tax introduced by the government in 2005 to discourage a number of IHT avoidance schemes, mainly involving the family home. You cannot give an asset away and still enjoy it - this is known as a reservation of benefit for IHT. HMRC will treat you as still enjoying the asset within your estate and tax it accordingly.

If you previously owned an asset and then continue to enjoy the use of it, or another asset derived from your original gift, this may give rise to liability for POAT. The POAT is collected through income tax and based on the benefit you are presumed to have from enjoying the asset. For example the value of occupying a property at a reduced rent - the POAT will be charged as part of your income based upon the market value of the rent. POAT relates to individual assets but also to cash, intangibles such as shares and insurance policies, land or chattels - basically every possible “gift” that you can make.

Making a Will can help you save Inheritance Tax and more

Properly drafted Wills can help achieve savings for a married couple or civil partners, but it is less easy for single people.

Wills can maximise business or agricultural property reliefs by passing such property into a trust on first death, with the remaining estate (that would ordinarily be chargeable to IHT) passing to your spouse to use the “spouse exemption”. A trust can also set assets up to the value of the NRB aside for children or others, but also allow the surviving spouse to have the use of the trust assets during his/her lifetime. Other advantages of a trust including “ringfencing” assets that may increase in value at a higher rate than the NRB. Trusts can help protect assets from a Local Authority financial assessment for care home fees contributions, and preserve them for children of a first marriage if your spouse remarries.

Conclusion

The solutions that we offer for IHT planning are tailored to your individual needs and circumstances. We can take you through the advantages and pitfalls to steer you through the taxation maze. There is no “one-size fits all” but there are many different ways of using the standard reliefs and exemptions, which we can help build into your lifestyle and family circumstances.

Particular care is needed if family circumstances are complex, with children from previous marriages, or marriages between people of different nationalities, or if assets such as holiday homes are owned abroad.

The law and practice referred to in this article has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.

The Legal 500 - The Clients Guide to Law Firms

UK Chambers logo

Best Companies - One to watch logo