Inheritance Tax (IHT) in the UK is a subject that was once something that only affected very wealthy people. It may be one of life's unpleasant facts but today it affects more people than ever, partly due to the rise in the property market that has not been matched by a corresponding rise in the IHT threshold.
The threshold is currently just £325,000 – any assets above this level are taxed at 40%. Married couples and registered civil partners have a joint estate of £650,000 before any IHT is payable. The threshold usually rises each year but has been frozen at £325,000 for tax years up to and including 2017/18. Unmarried partners, no matter how long-standing, have no automatic rights under the IHT rules.
Your estate consists of all the assets you own including your home, jewellery, savings and investments, works of art, cars, and any other properties or land – even if they are overseas.
It's usually payable on death. But there are certain circumstances (if you put assets into certain types of trusts, for example) when IHT becomes payable earlier. Any part of your estate that is left to your spouse or registered civil partner will be exempt from IHT. The exception is if
your spouse or registered civil partner
is domiciled outside the UK.
Nil rate threshold
Every individual is entitled to a 'Nil Rate Band' (that is, every individual is entitled to leave an amount of their estate up to the value of the nil rate threshold to a non-exempt beneficiary without incurring IHT). If you are a widow or widower and your deceased spouse did not use the whole of his or her Nil Rate Band, the Nil Rate Band applicable at your death can be increased by the percentage of Nil Rate Band unused on the death of your deceased spouse, provided your executors make the necessary elections within two years of your death.
Gifting it away
You are allowed to make a number of small gifts each year without creating an IHT liability. Remember, each person has their own allowance, so the amount can be doubled if each spouse or partner uses their allowances. You can also make larger gifts, but these are known as 'Potentially Exempt Transfers' (PETs) and you could have to pay IHT on their value if you die within seven years of making them.
Any other gifts made during your lifetime which do not qualify as a PET will immediately be chargeable to IHT and these are called 'Chargeable Lifetime Transfers' (CLT).
Gift With Reservation
If you make a gift to someone but keep an interest in it, it becomes known as a 'Gift With Reservation' and will remain in your estate for IHT purposes when you die. For example, if you gave your son your house, but continued to live in it without paying a market rent, it would be considered a Gift With Reservation. But if you continued to live there and paid him a market rent each month, it would become a Potentially Exempt Transfer and move out of the IHT net, provided you survived for seven years. However, your son would be liable to pay income tax on the rent he received.
Where the total amount of non-exempt gifts made within seven years of death plus the value of the element of your estate left to non-exempt beneficiaries exceeds the nil rate threshold, IHT is payable at 40% on the amount exceeding the threshold.
This reduces to 36% if the estate qualifies for a reduced rate as a result of a charity bequest. In some circumstances, IHT can also become payable on the lifetime gifts themselves – although gifts made between three and seven years before death could qualify for taper relief, which reduces the amount of IHT payable.
Some gifts you make during your lifetime are exempt from IHT. If you make a transfer to your spouse, this will always be exempt as long as they have a permanent UK home.
Your executors or legal personal representatives typically have six months from the end of the month of death to pay any IHT due. The estate can't pay out to the beneficiaries until this is done. The exception is any property, land or certain types of shares, where the IHT can be paid in instalments. Then your beneficiaries have up to 10 years to pay the tax owing, plus interest.
Taper relief applies where tax, or additional tax, becomes payable on your death in respect of gifts made during your lifetime. The relief works on a sliding scale. The relief is given against the amount of tax you'd have to pay rather than the value of the gift itself. The value of the gift is set when it's given, not at the time of death.
Write a Will
This is the first step in making effective plans. Whilst making a Will on its own does not reduce IHT, a Will makes sure your assets go to the people you choose quickly and with minimum effort. It also helps you to identify areas where you could take other action. If you die without a Will, your estate is divided out according to a pre-set formula, and you have no say over who gets what and how much tax is payable.
You need to keep your Will up-to-date. Getting married, divorced or having children are all key times to review your Will. If the changes are minor, you could add what's called a 'codicil' to the original Will. This is a document which can have the effect of making small amendments to your original Will.
Many people would like to make gifts to reduce IHT but are concerned about losing control of the money. This is where trusts can help. The rules changed in 2006 making some of them less tax effective, as a small minority will require you to pay IHT even before you have died, but if appropriate they should still be considered.
If you don't want to give away your assets while you're still alive, another option is to take out life cover, which can pay out an amount equal to your estimated IHT liability on death. Make sure you write the policy in an appropriate trust, so that it pays out outside your estate.
Policies written on a joint life second death basis – paying out when both of the couple are dead – can be the most cost-efficient way of mitigating an IHT liability.
On your death
When you die, your estate has to be distributed one way or another. If you have a Will, your executors have to gain a Grant of Probate in England and Wales or Northern Ireland (a Grant of Confirmation in Scotland). If there's no valid Will, or the named executors in the Will are unwilling or unable to carry out their duties, a Grant of Letters of Administration is needed. This is known as 'dying intestate'.
What could happen if you don't write a will?
The government lays down strict guidelines on how money is to be paid out if you die without making a Will. These could mean that a long-term unmarried partner ends up receiving nothing and the Crown gets all your estate.
INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.
THE FINANCIAL CONDUCT AUTHORITY DOES NOT REGULATE WILL WRITING, INHERITANCE TAX PLANNING OR TAXATION ADVICE.