Inheritance Tax Basics (IHT)
Inheritance Tax and You
Inheritance tax (IHT) receipts have surged by an astounding 22.9% in the first quarter of the tax year, and according to HMRC the amount of IHT paid in the last year has reached an all-time high. But what does this mean for the average person? We cover the basics on IHT.
What is IHT?
IHT is a transfer tax. It is charged primarily on transfers on death, which is what we will focus on, though there are some circumstances where IHT is charged on transfers in lifetime.
On death IHT is charged at a rate of 40% on all money, property and possessions, through some assets can be exempt. It will only be charged on the value of your assets over your nil rate band (NRB). Each individual has a NRB of £325,000 (2017/18). If you have previously married or been in a civil partnership and your spouse or civil partner has died then your estate may be able to benefit from their NRB too, provided they didn’t use it. So spouses and civil partners may benefit from a NRB of £650,000.
For example: Melissa dies leaving her £350,000 estate to Jerry. Jerry now finds himself with an estate worth £750,000. When Jerry dies his estate will have his own NRB and also Melissa’s NRB. £650,000 worth of assets can pass free of IHT, so IHT will only be charged on the remaining £100,000.
Are there any exemptions?
If you leave all of your estate to a spouse or civil partner then no IHT will be paid. This is due to the ‘spouse exemption’ provided for by section 18 of the Inheritance Tax Act 1984.
Similar exemptions apply to gifts to charity. Any gifts made to charity in your Will (and also in lifetime) are free of IHT.
There are also further exemptions if you own a business or agricultural property. Certain business and agricultural property qualifies for ‘Business Property Relief’ or ‘Agricultural Property Relief’. This is a complex area so if you have interests in a business, farm, or woodland we would recommend you seek professional advice.
When is IHT paid?
IHT must be paid by the end of the sixth month following your death. If it is not paid within this time then HMRC will begin to charge interest. In some circumstances it can be paid in instalments over a 10 year period, but only on certain assets such as property.
The IHT is paid by your executors – the people you appointed in your Will to administer your estate after your death. It is paid out of your estate, though is some cases the executor will pay the IHT out of their own pocket and reclaim this from your estate.
A beneficiary won’t normally pay any IHT on assets they receive. They may have to pay IHT if the estate is unable to, or if you made a gift to them within the 7 years immediately before your death.
Can I mitigate IHT?
There are various ways to mitigate IHT, the most effective being to reduce the size of your estate while you are alive.
Consider making gifts in lifetime. Individuals can give away up to £3000 a year without any charge to IHT. If you didn’t use your allowance last year then this can be brought forward and you can gift £6000 free of IHT.
There is a ‘small gifts exemption’. You can give as many gifts of up to £250 per person as you want during the tax year as long as you haven’t used another exemption on the same person.
Any relatives getting married? You can make gifts to them free of IHT, though how much you can gift depends on your relationship to the happy couple. You can gift £1000 to anyone. £2500 to a grandchild, or £5000 to your own child.
You can take advantage of the ‘normal expenditure out of income’ rule and make gifts out of your regular income. This will be IHT free so long as your regular standard of living is not effected. This could be in the form of maintenance for your spouse or children, or even regular gifts for special occasions.
You could consider gifting property or larger sums of money away in lifetime. Provided you survive by 7 years these will be free of IHT. Gifts like these are known as PETs.
Consider transferring some assets to a trust. You can’t retain any benefit from the asset in the trust though, or this will still form part of your estate for IHT when you die. We’d recommend specialist advice on transferring assets to trust since trusts are also taxed in their own right.
The Residential Nil Rate Band
This April (2017) a new IHT threshold was introduced. The ‘Residential Nil Rate Band’ is available to anyone who owns a property that they have used as a residence at some point so long as they leave the property to their ‘direct descendants’ (children, grandchildren, step-children etc.). It’s currently worth £100,000 but is increasing by £25,000 per year until it reaches £175,000 in 2020/21. So currently you could have an IHT threshold of up to £425,000, or £850,000 for spouses.
This new threshold may not be available if your estate is in excess of £2million (the taper threshold). For each £2 your estate is over the taper threshold the RNRB will be tapered away by £1.