The only things certain in life are death and taxes. The rules for inheritance tax however, cannot be put so succinctly. As tax specialists, we provide sensible advice and help you make sense of the complexities. You’ll gain clarity and structure for your inheritance tax planning and help your loved ones save on as much inheritance tax as possible.
For some basic guidance on allowances, exemptions, exceptions and taper relief, see below.
In the UK, everyone has an allowance of up to £325,000 which can be passed onto whoever they like tax-free. This amount is called the Nil Rate Band. The amount has currently been frozen at £325,000 until 2020/21. Any assets over this amount will then be subject to tax at a rate of 40%.
The Nil Rate Band does not apply if you are passing on assets to your spouse or civil partner. This means that you can give more than £325,000 to your partner without incurring tax. However, if your partner is not a UK-domicile then the allowance reverts back to the Nil Rate Band.
In addition to the Nil Rate Band, the Residence Nil Rate Band was introduced in April 2017. It is specifically related to your residential property and allows you to pass on your home to direct descendants tax-free up until a certain amount. The allowance is £100,000 for 2017/18, £125,000 for 2018/19, £150,000 for 2019/20 and £175,000 for 2020/21. This therefore makes the total sum you are allowed to pass on as inheritance tax-free £450,000 for 2018/19 (rising to £475,000 for 2019/20). The Residence Nil Rate Band is affected however if your final estate (your remaining valuable assets after death) is worth more than £2 million. If this is the case, then your Residence Nil Rate Band will be tapered away depending on the final sum of your estate.
Nil Rate Bands (including the Residence Nil Rate Band) can be passed onto spouses or civil partners. If your partner passed away before you and did not use their maximum allowance, then your own allowance increases by the percentage that was unused.
Ways to Save on Inheritance Tax
Inheritance tax does not only apply to assets after one has passed away, but can affect gifts you make whilst still alive. Nevertheless, using your annual gift allowance is a good way to minimise the beneficiaries’ inheritance tax liability.
Each year you can give away assets or cash of up to a total of £3,000 tax-free. You can also carry over any leftover allowance from one tax year to the next, but only to the maximum of £6,000. If you give away any more than this, the amount of tax due will depend on whether or not the gift was given within 7 years before the person died. It works on a taper relief system:
- Gift made 3 – 4 years before death – 20% relief
- Gifts made 4 -5 years before death – 40% relief
- Gifts made 5 -6 years before death – 60% relief
- Gifts made 6 – 7 years before death – 80% relief
- Gifts made over 7 years before death – no inheritance tax due
A family member gifts you £500,000 in May 2006 and passes away in December 2012. The nil-rate threshold when the family member died was £325,000 which means that £175,000 is subject to inheritance tax deductions. At the normal 40% inheritance tax rate you would normally have to pay £70,000 so reducing your inheritance to £105,000. However, the gift was made between the 6 – 7 year period so you would receive taper relief of 80% off the £70,000 leaving you to pay £14,000 inheritance tax therefore allowing you to keep £161,000 in addition to the tax-free amount of £325,000.
Gifts Exempt from Inheritance Tax
There are some gifts which are completely free from inheritance tax.
- Small gifts with a value of under £250 per year. You can give as many of these gifts as you like to as many people, however it cannot be to someone who would have already benefited from a gift of up to £3,000.
- Wedding gifts which must be given before the wedding, and where the wedding must happen. The allowance is £5,000 for children, £2,500 for grand-children, and £1,000 for friends or any other person.
- Gifts to help with living costs of dependants are also exempt, such as if you want to help with care costs of an elderly relative, or education costs for children under 18.
Other options to save on inheritance tax:
Understandably, many people will have very specific wishes on how their wealth is distributed after their death. We’ll find the best possible solutions to achieve this in the most tax-efficient way.
- Set up a trust to ensure assets are passed on and used in the way you intend for them to be used, such as help pay for children’s education or buy their first property. We can assess the most advantageous way to set up a trust and advise on potential Capital Gains Tax or Income Tax liabilities.
- Leave at least 10% of your overall estate to charity and other beneficiaries can benefit from a reduced inheritance tax rate. When you do this, the standard inheritance tax rate of 40% becomes reduced to 36%.
- Keep the family business within the family. In many cases, passing on a business is completely exempt from inheritance tax, however you must have owned the business for at least two years and the business must be carried out for gain. Speak to us to make sure your business will qualify for Business Property Relief.
- Pass on unused pension. Where a person dies before the age of 75, they are eligible to pass on their pension completely tax-free. Once over the age of 75, the beneficiary may draw out the cash from the pension at their own income tax level. For those on the lower 20% rate, this is a significant saving from the 40% inheritance tax rate that they would have to pay had they received the cash outside of the pension pot. This has to be set up directly with the pension provider and is only applicable on some types of pensions so make sure you speak to an expert in order to arrange this.