Understanding Inheritance Tax

Understand what is involved in the current Inheritance Tax Laws 

Inheritance Tax

Inheritance Tax (IHT) is a tax payable on your estate at the time of your death.  Your estate is made up of your total assets minus any debts.  There is a nil tax threshold of £300 000, over which tax is payable at 40%.  Inheritance tax is also payable on various valuable gifts (Potentially Exempt Transfers) given in the last seven years of your life. 

What is exempt from Inheritance Tax?

• Your assets valued at below £300 000 are exempt from IHT.  Only the excess above this will be taxed; for example, if your entire estate is valued at £400 000, only £100 000 will be taxed at 40%, not the entire amount.

• Donations to registered UK charities

• Donations to certain UK national institutions

• Donations to UK political parties

• Leaving your assets ‘in-trust’ so that they don’t form part of your estate 

How can I avoid inheritance tax?

Inheritance tax is highly unpopular in the UK; after all, you have paid taxes on your income and investments throughout your life, why should your family then be hit with a further tax when you die, on assets that have already been taxed?

The most valuable asset you are likely to own at the time of your death is your home.  With housing prices in the UK at a record high, even if you don’t have many valuable liquid assets or investments, your home is likely to push your estate value over the tax-free threshold.  Add to this any life insurance payouts – especially whole of life insurance policies – and the likelihood of your estate being taxed at 40% is probably quite high.  However, in order to prevent you from relinquishing ownership of your home during your lifetime as a Gift with reservation of Benefit, your home will still be included as a part of your estate.  Unfortunately there is no way around this, as laws regarding gifts with reservation of benefit are put in place to ensure that the taxman will still get a chunk of your estate; so even if you give your home as a gift to one of your children but continue to live there rent-free until your death, it will still be included when tallying up the assets that make up your estate.

However, there are certain gifts that can be made during your lifetime in order to reduce your capital.  These include:

• gifts between married couples and civil partnerships

• gifts of any value made more than 7 years before your death

• as wedding gifts parents may each give their child £5000, grandparents may give £2500 and others may give £1000

• Small gifts of value up to £250 are able to be given to as many people as you like, no more than once per person per tax year

• Annual exemption on gifts up to £3000 per tax year; this can be carried forward for one year so that up to £6000 may be given on the next year

• Normal expenditure from your after-tax income; must be provable to not be reducing your capital

• Maintenance payments to husband/wife, ex-spouse/civil partner, dependent relatives, dependent children under the age of 18 or in full time education

Anything more than this is considered a Potentially Exempt Transfer, and will be taxable as part of your estate if you die within seven years of the giving; however, if you should outlive the seven years, the taxman can’t touch it! 

Gifts with Reservation of Benefit

Reducing the value of your estate is a way to avoid it incurring inheritance tax; however, the government has in place certain restrictions as to how many assets may give away during your lifetime – because they would rather have a chunk of your money!  

A gift with reservation of benefit remains part of your estate for tax purposes, even if you survive the giving by more than seven years.  These are gifts that are viewed by the government as an attempt to reduce your estate and so avoid inheritance tax, and include gifts that you will continue to benefit from.  An example of a gift with reservation of benefit includes transferring the ownership of your home to your children but continuing to live rent-free in the house until your death.   

Trusts

The use of trusts in keeping your estate away from the taxman is complex, and you should consult your solicitor or independent financial advisor for in-depth advice and recommendations on your individual financial circumstances.  Briefly, trusts work by effectively keeping your money and assets in other people’s names, which either pays you an income or is left to the named benefactor upon your death.  For example, writing a new life insurance policy ‘in-trust’ to a named benefactor will mean that when you die, the payout will go directly to that person rather than making up part of your estate.  As life insurance policies can pay out hundreds of thousands of pounds – even more if you have used a savings/investment vehicle – keeping this separate from your other assets can make a big difference to the amount that the taxman will receive.   

Get your affairs in order

Your affairs need to be in order at all times.  Having an official Will drawn up will enable you to nominate where your assets will be distributed after your death. Not having a Will means that the government may have access to more of your money that they otherwise would – particularly if you are not married.  Will kits are widely available as a do-it-yourself option for around £10, but you should be aware that a Will is a legally binding document, and that mistakes can have far-reaching effects if not remedied before your death.  In particular, if your affairs are complex you should most certainly seek a professional for advice regarding drawing up your Will.

Please note: this website, and the articles and information within it are based on journalistic research. It does not and should not be construed to constitute financial advice. Any information should be considered in regard to specific circumstances. All tips are followed at your own risk and should be followed up with your own research.  For more please refer to our terms and conditions of use.