Amongst the ballyhoo about the ‘reform’ in the cost of care last week, you may not have noticed a new £95,000 stealth tax on inheritance. The current £325,000 threshold, below which no tax is liable, has remained the same since 2009. In his autumn statement nine weeks ago, George Osborne promised to increase it to £329,000 in 2015. He has now frozen the threshold until at least 2019
To keep pace with inflation, the threshold would need to increase to £420,000 by 2019 — meaning the allowance will in effect be worth £95,000 less by then
Inheritance tax is already one of the most hated taxes because it taxes your loved ones for possessions and investments that you have already paid tax on. But there are steps you can take now to mitigate it in the future. NMTBP shows you how:
What is IHT and will it affect me?
IHT is levied on your wealth, or estate, after you die. The tax is 40% on estates over the threshold of £325,000, known as the ‘nil rate band’. Your estate includes any property, possession, money, savings and investments you may have. Assets held in trust and even gifts you made when alive could all be liable for IHT
Many people think IHT is only paid by the super-rich, but thanks to a decade of unprecedented house price rises even those with modest homes – especially in London and the South East – could see themselves fall into the IHT trap, especially now that the threshold has been frozen until 2019
How can I avoid IHT?
IHT is an unpopular tax but there are ways to arrange your financial affairs to minimise your bill, or even escape IHT altogether
You can reduce your estate but making ‘exempt gifts’ including to your spouse or civil partner, as long as they have a permanent home in the UK
Other stranger exemptions include donations to some national institutions, such as museums and universities, and the National Trust. You can also give money to political parties that have at least two members elected to the House of Commons or has one elected member but the party received at least 150,000 votes
Some estates are completely exempt from paying IHT. Exempt estates include those:
- valued at under £325,000
- where the deceased left everything to a spouse or a qualifying charity and the estate worth is under £1 million
- owned by someone domiciled in a foreign country who died abroad and has a UK estate valued at less than £150,000
If your estate qualifies as exempt you will need to fill in HMRC’s IHT205 Return of Estate Information form (known as C5 in Scotland)
If you’re unaware of how much your estate is worth for IHT purposes, it is worth employing a professional valuer to help you determine the price of property and possessions. Don’t guess!
Can’t I just give my money away before I die?
Gifting your money away falls into two categories: tax-free gifts and potentially exempt transfers (PETs).
Tax-free gifts include:
- those between spouses or civil partners who are both domiciled in the UK. If one party is domiciled abroad, the gift is capped at £55,000
- those to national institutions, museums, universities, the National Trust, small political parties, housing associations and amateur sports clubs
- those to people getting married. If you are a parent of the couple marrying you can gift £5,000, £2,500 if you are a grandparent or other relative, £2,500 each between bride and groom or civil partners. Anyone else can give £1,000
- those made out of ‘normal expenditure’. If you can prove the money you are giving away is out of surplus income then it becomes tax-free. To qualify the gift must not reduce your standard of living and is not from capital. It must also constitute a regular spend so if you want to give away a little each month it is best to set up a standing order from your current account
- up to £250 at any one time for birthdays, Christmas presents etc
- gifts for maintenance of spouse, ex-spouse, civil partner or ex-civil partner. The gifts are also exempt if made to relative who are dependent on you because they are elderly, infirm, children in full-time education
In total you can give away gifts worth £3,000 each year and can also carry forward any unused allowance but only from the immediately previous year, if you don’t use it, it expires
Potentially exempt transfers (PETs):
PETs are gifts that do not immediately fall into the tax-free gifts category but could become tax free in future. A PET becomes an exempt transfer if the donor lives for seven years after gifting the money to the individual or organisation
However, if the donor dies within seven years the PET becomes a chargeable transfer and the person who received the PET will be asked to pay 40% IHT on it. The amount of tax is calculated using taper relief, meaning the older the gift, the larger the reduction in tax
If the gift was made less than three years before death there is no reduction in the tax charge. For gifts made three to four years before death tax is reduced 20%; 40% for gifts made four to five years before death; 60% if made five to six years before and 80% if made six to seven years before
Remember that if a PET fails (in other words you die before seven years is up) it is effectively taxed twice. Not only does the recipient of the gift get taxed but the PET is also added to the overall total of your estate for IHT calculation purposes
It’s worth noting that if you wish to give 10% or more of your estate to charity the rate of IHT for your whole estate (above the nil rate band) is reduced from 40% to 36%
Can nil rate bands be combined?
Nil rate bands can be combined, up to £650,000, for spouses and civil partners – unfortunately you cannot combine your allowance with whoever you please!
If your other half dies and leaves everything to you – all their possession and their half of the house – then the estate becomes exempt from IHT (remember transfer of estate between spouses is tax exempt). It doesn’t matter how much is passed on as long as the person receiving the assets has their permanent home in the UK.
This means that your other half didn’t have to use their nil rate band of £350,000 and so it can be passed to you. If your spouse has assets that they did not leave to you then you will receive their allowance minus the value of those assets
On the death of the second spouse, you, your loved ones whom you leave your estate to will benefit from the use of two nil rate bands – meaning an estate of £650,000 (if the second spouse receives the deceased spouse’s full allowance)
A nil rate band of £650,000 is usually enough to push most estates out of IHT, but certainly not all
If there is an IHT bill, who pays it?
If there is IHT to pay to HMRC, it is typically paid by the executor of the deceased person’s will or their personal representative
The IHT bill is paid from the funds of the estate and must be paid with six months from the end of the month of the person’s death. If you fail to pay the bill in this time HMRC will begin to add interest to the amount owing. This means that, in most cases, the family home will need to be sold
IHT can, however, be paid in instalments over a 10 year period if arranged with HMRC. This is usually when land and property assets have been left
Are there any other ways to avoid IHT?
Yes, there are investments that you can make throughout your lifetime that will be exempt from IHT when you die, which could be a good way to reduce your bill. These include:
- AIM shares
- Forestry and farmland
- Enterprise Investment Schemes (EIS)
- Business property
IHT is a complex area and it is always worth taking the advice of a professional if you want to do more than just gift money to family
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