A Guide to Inheritance Tax
A Guide to Inheritance Tax 25 November 2022 Written by James & George Collie

When you die, you may want to leave specific assets to specific people, but having to pay Inheritance Tax may reduce the amount of your estate quite drastically. In 2021/22 a record total of £6.05bn was paid in Inheritance tax. This article will look into ways of estate planning; preventing the taxman from getting his hands on your assets before your chosen beneficiaries.

What is Inheritance Tax?

Although only a small percentage of estates are large enough to incur Inheritance Tax (IHT), it is important not to forget to take it into account when making your Will. Inheritance Tax is a tax on the estate of a deceased person. The estate is comprised of all property, possessions and money.

Inheritance tax is charged on chargeable transfers made during the deceased’s life and on the value of the estate at the time of death. The current threshold for IHT (otherwise known as the “Nil Rate Band”) is £325,000, with a rate of 40%. This threshold will remain the same until 2026.

So to make this more clear

John’s estate was valued at £600,000. The threshold for IHT is £325,000. Therefore, £275,000 of John’s estate is liable for tax at the rate of 40%.

So the IHT will be charged on £275,000 of John’s estate, totaling to £110,000 tax.

Married couples and civil partners

Although the Nil Rate Band (NRB) is fixed at £325,000, it may be increased if you are widowed or a surviving civil partner. Couples have the power to transfer any unused NRB when the first spouse dies.

This can double the NRB of the surviving spouse/civil partner, meaning their NRB will be available up to £650.000.

So to make this more clear

At John’s time of death, his NRB was £325,000. Under John’s Will, he left his entire estate to his wife Jane. As Jane survived John, his NRB transfers to her estate, meaning that her NRB is now £650,000 (£325,000+£325,000). This means that Jane’s estate will not be subject to IHT unless overpasses her £650,000 threshold.

Residential NRB

The UK Government introduced the residential nil rate band in 2017 as an additional tax-free amount which could be passed on against the value of the family home. The Residential Nil Rate Band is currently £175,000. This sum is in addition to the NRB, meaning that a married couple or civil partnership could potentially pass on up to £1 million free of IHT.

This can save you thousands of pounds worth of tax, however the rule is you have to pass the property on to direct descendants (children, including foster, adopted or step-children or grandchildren). You cannot use the residential nil rate band if your home is passed on through a discretionary trust.

Make a Will

This plays a major part in estate planning, ensuring that all of your assets are distributed according to your wishes. If you were to die without a Will (Intestate), your estate will be distributed accordingly to the intestacy rules and may be liable to IHT which could otherwise be avoided. Our firm offers Will writing services, get in touch if you are interested.

There are ways to minimise your tax liability

Annual exemptions

You can utilise your annual exemptions. Each taxpayer in Scotland has an exemption of £3,000 per year.

Lifetime transfers

IHT would only be payable at the time of your death, and the time passed since the date of your death would be considered. If a transfer is made seven years prior to your death, it is fully exempt from IHT. If the period between the transfer and death is between 3-7 years, then taper relief is available to relieve the IHT liability.

Marriage gift exemptions

If you have children, you can gift up to £5,000 to each child without tax liability.

Small gifts

You can make small gifts of £250.00 per year without tax liability. The gifts must form part of your normal expenditure and be made out of income. It is important to ensure that gifts do not lessen your standard of living.

Donating to charities

If you leave 10% of your estate to charity, the rate of tax payable on your estate would diminish from 40% to 36%.

Life policies under Trust

If you leave a lump sum to a beneficiary under Trust, it would not be subject to tax. You could pay into a discounted gift trust, limiting the IHT liability even further. A fixed regular payment of your chosen sum can be made until your death, meaning your chosen beneficiaries would receive a sum which could avoid IHT. You can also cover potential liabilities by taking out a life insurance policy for the inheritance tax bill and place it into a trust, ensuring it is paid outside of your estate.

Gifts out of Income

Gifts out of income are free from IHT. There is no limit to the value which can be transferred or gifted, as long as the three conditions are satisfied.

Firstly, the gift has to be deemed as a “normal” gift. The frequency of the gift is often an indicator of the normality of the gifts, however this does not mean that gifts are always made with precise time parameters. The value of the gift should contain an element of consistency. The nature of the gift will be considered as well as to whom is the gift being made.

Ordinary expenditure

Spend your money and don’t feel bad about it!

If you have worked hard to build up your assets, enjoy them to their utmost, perhaps a new car or a holiday is on the cards?

Pension incomes are also classified as income, you could look into arranging monthly transfers to your children, making these regular transfer exempt from IHT.

These are some of the most practical methods of diminishing your IHT liability. The basics of IHT planning are relatively straightforward, and most people can take effective actions without difficulty. However, if your affairs are more complex, it is worth to seek advice from a professional such as ourselves. If you would like to receive more information on this, contact one of our Private Client solicitors for further information.

Written by Agata Clark

get in touch

Please let us know your name.
Please enter a valid phone number
Please let us know your email address.
Invalid Input
Invalid Input
Please let us know your message.