Inheritance tax (IHT) is based on the value of your estate when you die. This may include the value of assets you have given away or put into trust during the previous seven years. Careful planning can reduce or even eliminate the IHT payable and is an important part of drawing up or reviewing your will
IHT is not payable on the first part of the value of your estate – the ‘nil-rate band’. The nil-rate band is currently £325,000 (and will be held at this level until 2014-15). If the total value of your estate does not exceed the nil-rate band, no IHT is payable. Note: outstanding debts and funeral expenses can be deducted from the value of your estate.
In addition, various gifts are exempt from IHT:
If the first to die does not use up his or her entire nil-rate band, then the surviving partner (in a marriage or civil partnership) will be entitled to a proportionate increase in the nil-rate band when she or he dies. For example, if a husband dies leaving everything to his wife, his entire estate is exempt from IHT. In this case, on the subsequent death of the wife, her estate would benefit from a doubling of the nil-rate band.
Provided that you can afford to do so, giving away assets can be a very effective way of reducing the value of your estate – and so reducing any eventual IHT payable.
Although gifts made during the seven years prior to your death are included in your estate, there are several exemptions that allow you to immediately reduce the value of your estate:
Importantly, regular gifts out of income that do not affect your standard of living are exempt. This can be of significant value if you have a substantial income. For example, you might make regular contributions to a life insurance policy to help cover the IHT that you expect to be payable when you die.
Gifts of capital for the maintenance of dependant relatives (such as children, former spouses and disabled relatives) are also exempt.
Lifetime gifts that are not covered by one of the exemptions, and are not gifts to a trust, are potentially exempt transfers (PETs). Provided that you survive for at least seven years, the gift will no longer be included within your estate and no IHT will be payable.
If you die within seven years, IHT is calculated on a sliding scale (known as ‘Taper Relief’):
Less than three years, the full rate of IHT is charged at 40%.
In order to qualify as a gift, you must not continue to have any benefit from the assets you have given away. For example, if you give away your house – but continue to live in it, rent-free – the house will remain part of your estate and so liable to IHT when you die. Similarly, if you put assets in trust – but either are or could be a beneficiary of the trust – then they will remain within your estate.
In addition, if you give away assets but continue to benefit from them (eg keeping a valuable painting that you have ‘given away’) you may be liable to an income tax charge. This pre-owned assets tax (POAT) is based on the value of the benefit: for example, the rental value of a house or the market value of an asset such as a painting.
If you pay a market rent to occupy a property you have given away, then it does qualify as a potentially exempt transfer and you are not subject to the POAT. However, the income tax that the recipient will be liable to on your rental payments may well outweigh any IHT savings.
If you have entered into any arrangements such as this, you should take immediate advice.
As part of your inheritance tax planning, you may want to consider putting assets in trust – either during your lifetime or under the terms of your will. Putting assets in trust – rather than making a direct gift to a beneficiary – can be a more flexible way of achieving your objectives. For example:
The tax treatment of trusts is complex, and depends on such factors as the kind of trust, the value of the assets put into it, and who the beneficiaries are. Recent changes to the rules mean that the tax treatment of many trusts is no longer as favourable as it used to be, but there are still circumstances in which they can help to reduce the overall level of tax payable.
You should take advice on whether trusts could be of benefit for your particular circumstances and requirements.
Many forms of business assets qualify for substantial IHT reliefs. Investments in most unincorporated businesses (eg a partnership) and unquoted companies (including most AIM shares) qualify for 100% relief. Most assets used by a business that you controlled or were a partner in qualify for 50% relief.
Similar reliefs apply to agricultural property (such as farms) and woodlands.
To qualify, the assets must have been owned for two years prior to death. In addition, there are some restrictions: for example, investment and property businesses are generally excluded. There are also restrictions to prevent relief being claimed on ‘farms’ that are in reality being used as homes.
Death benefits from most pension schemes also fall outside the scope of IHT, though it is worth taking advice – particularly if you are planning to set up a new scheme as part of your IHT planning.
Special rules may apply to overseas assets, and where either you or a beneficiary (eg your spouse) is domiciled outside the UK. Again, advice should be taken to ensure that your planning takes into account any local laws overseas as well as relevant UK legislation.
As well as considering opportunities to reduce IHT, effective IHT planning should take into account the practicalities of paying IHT and releasing assets to your chosen beneficiaries.
Assets cannot usually be sold or distributed until HM Revenue and Customs (HMRC) has received a full statement of your estate, and has been satisfied as to the payment of any IHT due. This may mean that the IHT due needs to be paid. (IHT can be paid in instalments over up to 10 years – plus interest – for some assets, in particular your house).
This has two important practical consequences:
The complexity of IHT law provides substantial planning opportunities. Effective planning should take into account a number of key principles:
A professional advisor who fully understands your objectives and personal circumstances can help you develop an IHT plan tailored to your particular needs.
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