What Is IHT?
IHT is a tax charge on any part of your estate that exceeds your personal allowance (also known as the nil rate band). Your estate is the combination of your property, savings, investments, other assets and any gifts you gave away in the 7 years leading up to your death.
It’s usually charged at 40% but drops to 36% if you give away at least 10% of your estate to charity. So, every £1,000 reduction in your estate will save £400 in IHT. For every £100,000, that means £40,000!
Nil Rate Bands
The nil rate band is your personal allowance that’s free from IHT. It’s currently £325,000 per person.
Any unused allowance can be transferred between married couples and civil partners when they die, meaning you could potentially pass on up to £650,000 without your beneficiaries paying any IHT.
The residence nil rate band (RNRB) is a 2nd allowance for passing on the family home. It was introduced in April 2017 and is currently £175,000 per person on top of the nil rate band above.
The RNRB can also be transferred between spouses which means married couples and civil partners could potentially leave £1 million to the next generation with no IHT to pay.
The RNRB is tapered down for people with larger estates. It reduces by £1 for every £2 your estate is over £2 million.
Finally, the RNRB only applies to the family home (not a second home or buy-to-let property) and can only be used when passing on assets to direct descendants.
Can You Afford to Give Money Away NOW?
Recent surveys show that around £5.5 trillion pounds of wealth will be transferred out from the over 60s generation over the next 20-30 years. That’s a BIG number!
But a balance needs to be struck between wanting to gift money (hopefully, to grateful recipients) but keeping enough back so you don’t have to worry about your own future.
We’re all living longer so it’s important to make sure we don’t give away too much and we maintain a cushion of wealth to pay for our health and (possibly) care needs in the future as well as the things that bring us joy.
Outright Gifts
Depending on your situation, making gifts during your lifetime could be a great way of reducing a potential IHT liability on death. Lifetime gifts fall into one of three categories:
1. Exempt gifts which are ignored for IHT purposes both when they’re made and also on subsequent death.
2. Gifts to most types of trust are immediately liable to IHT when the gift is made as Chargeable Lifetime Transfers (CLTs).
3. Any other transfers classified as Potentially Exempt Transfers (PETs) are only liable to IHT if the donor dies within 7 years of the date of the gift.
Any gift made, whether into trust or directly to a person, should be unconditional which means you should derive no benefit from the gift, otherwise it will be considered for IHT purposes to be a ‘gift with reservation’ (GWR) and it will fall back into your estate for the purposes of calculating tax.
Small Exempt Gifts
Certain gifts leave your estate immediately after being made, and are therefore free from IHT:
An annual gifting allowance of £3,000 which can be split between as many people as you like, and if you don’t use it you can carry it forward one year for a maximum allowance of £6,000.
Wedding or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild and £5,000 for a child).
You can make as many small gifts of up to £250 but they can be no more than £250 per person. A lot of people get caught out with this one!.
Regular gifts out of your excess income, as long as they won’t affect your normal lifestyle. That’s important. You need to demonstrate your lifestyle hasn’t been affected by gifting in this way.
Unlimited gifts to charities, museums, universities, sports clubs and some political parties. For a lot of people, this is an attractive option.
Using Trusts
Trusts make it possible to give to others while keeping control of the money. This is useful if you want to make a gift to someone who would be unable to look after it for themselves. You could give the gift while keeping control over how, when and in what circumstances it’s received.
Gifts into bare trusts, trusts for disabled people and certain trusts for children where they become absolutely entitled to the trust property at age 18 qualify for treatment as PETs, however, gifts into most other types of trust, particularly where there’s an element of flexibility about who will benefit and when, are classified as a Chargeable Lifetime Transfer (CLT).
A CLT may be immediately liable to an IHT charge at 20% if the value of the transfer to the trust or if the cumulative value of CLTs over the last 7 years, exceeds the available nil rate band.
In some circumstances you can make a capital gift while keeping the income or keep an investment while giving away the growth. These options can be a bit complicated!
Potentially Exempt Transfers
If you make a gift that’s not exempt or a CLT, it’s known as a Potentially Exempt Transfers (PET).
PETs temporarily reduce your NRB by the value of the gifts made. As such, if you make a gift, you must live for 7 years to ensure the value is not added back into your estate for IHT calculations.
Keep a record of any gifts you make, as your executors will have to account for any gifts you made during the last 7 years of your life.
What if You Don’t Want to Gift!
For various reasons, giving money away during your lifetime might not be the right thing to do. Where does that leave you? Here’s a few things to think about.
Pensions
Money left in a pension when you die doesn’t form part of your estate and isn’t included when IHT is calculated. If you can use other income to fund your retirement, you can pass any pension fund remaining in your pension on to your beneficiaries without IHT.
Business Relief
Investments or assets that qualify for Business Relief leave your estate after just 2 years. After this you can either continue to keep them invested and retain their IHT status or you can bring them back into your estate to use later in life, for any unexpected expenses.
You can claim Business Relief on:
A business or interest in a business (such as being a partner).
Land, buildings or machinery owned by a partner or controlling shareholder of a business.
Unquoted shares such as those listed on the alternative investment market (AIM).
Investments that qualify for business relief are usually complex so they tend to suit experienced investors who are prepared to take on more risk.
Life Insurance
One of the simplest ways to manage IHT is to take out a life insurance policy that pays a lump sum to your beneficiaries when you die.
They can then use this money to settle the IHT bill without the stress and upset of having to sell the family home or your other possessions.
Spending
SKI-ING (Spending the Kids’ Inheritance) is a great way of reducing your IHT bill and shouldn’t be discounted as a very efficient strategy! Live the life you want, we don’t know how long we have left!
Contributing to Society
Some people are happy to pay IHT, believing it to be their fair contribution to society as a whole. In my experience this needs to be discussed with family members to avoid some nasty surprises when their loved one passes on!
Get Married!
If you’re married or in a civil partnership, the assets you leave to your spouse will be transferred without any IHT. Also, leaving assets to a spouse does not use up your nil-rate band.
When someone dies, their unused NRB and RNRB can be transferred to their spouse or civil partner. For example, if your spouse left everything to you before they died, you could have a combined exemption of £1,000,000 applied to the value of your own estate when your time comes.
If you are part of an unmarried couple, you are still treated as single for IHT purposes which means each of you has a separate nil-rate band of £325,000 which can’t be combined upon death. Perhaps a very good reason to get married!
The End!
I know this has been quite a long one. Thanks for getting to the end! I hope it’s been useful and please do talk to me if anything I’ve written resonates with you or you need more detail.
Catch up with you soon!...