Inheritance Tax

Inheritance Tax (IHT) is a tax placed on the estate you leave behind when you die and it can also be placed on gifts given during your lifetime. During the 2014/15 tax year, the tax free allowance for IHT was £325,000 and this will not be changed until 2017 at the earliest.

Your Guide to Inheritance Tax

Rates & Thresholds

Your estate includes property, investments, cash and other assets but it is not given a final value until debts and expenses (like funeral costs) are deducted. If your estate is worth more than £325,000, the rest of it will be taxed at 40%. This means if your estate is worth £525,000, it is £200,000 over the tax free limit. The result is an £80,000 tax bill for your dependants.

Rules For Married Couples & Civil Partners

If you are married or are in a civil partnership, you can pass your estate to your other half tax-free and since October 2007, the surviving partner is able to use both tax-free allowances as long as one wasn’t used at the time of the first partner’s death. This ensures the surviving partner doesn’t need to worry about tax planning until the estate goes above the new tax threshold. Please note that there is a loophole in place; if your partner died before 21 March 1972, you don’t get this double allowance.

Tax-Free Gifts

Here is a list of the gifts you can make tax-free at any time:

  • Gifts made to people more than seven years before your death.
  • An unlimited amount of gifts up to the value of £250 to each recipient.
  • An annual exemption of up to £3,000 in a year; this cannot be combined with a £250 gift to the same person.
  • Gifts for people getting married. This includes up to £5,000 from each of the couples’ parents, £2,500 from a grandparent or remote relative, £2,500 from bride to groom and vice versa and £1,000 from anyone else.
  • Gifts for maintenance; these gifts are to people dependent on you through infirmity or old age or maintenance for kids under the age of 18 or if they are in full-time education.
  • Gifts as part of ‘normal expenditure’ which relates to money given from your surplus income that doesn’t decrease your standard of living.
  • Gifts to universities, museums, charities and other UK established organisations that accept legacy gifts. This also includes gifts to political parties.
  • Gift between spouses or civil partners who both have their main residence in the UK. The amount is limited to £55,000 if one of the partners is overseas.

Taxable Gifts

Gifts to companies and the trustees of most types of trusts are taxable. However, you won’t have to pay tax at the time if the total of all gifts given in the previous seven years is below the IHT threshold. For example, if Mike puts £200,000 into a trust in January 2012 and has made no gifts in the last seven years, he won’t pay tax. However, if he dies before January 2019, the tax free allowance of £325,000 will be reduced by that £200,000 so only £125,000 is applied against the rest of Mike’s estate when he dies.

Reducing IHT

One of the easiest ways to avoid IHT is to give a large part of your estate away before you die. If your wealth is tied up in property, you can take out an equity release scheme. This involves borrowing money against your home’s value or else you can sell your house at below market rate yet remain living there until you die (this is known as a home reversion scheme).

The money released can then be passed to your heirs and as long as you live for more than seven years after giving these gifts, there will be no IHT to pay. Once you die, the value of your estate gets reduced by the mortgage debt or else it will be reduced because only a portion of the value of your home is still part of your estate. One issue with taking out this kind of mortgage is that the interest gets ‘rolled up’ which can lead to substantial debt. In other words, you could be allowing the bank to take a slice of your estate just to stop the taxman getting there first!

When it comes to IHT, it is always best to make a Will as this can help you understand the value of your estate and determine how much IHT it will be subject to, at the same time you should be talking to an Independent Financial Advisor to see what you can do whilst still alive. Then you can engage in a strategy to reduce or erase what would otherwise be owed to the taxman.