Inheritance Tax

Inheritance Tax (IHT) is a tax on an individual’s estate. The definition of estate includes everything an individual owns, when they die and covers heritable assets (e.g. houses, land and buildings) and moveable assets (e.g. money in the bank, shares, some insurance policies, furniture and personal effects). The standard IHT rate is 40% of the net estate. IHT is paid from the deceased’s person’s estate within 6 months from date of death before the distribution of funds to the beneficiaries.

There will be no IHT to pay from a person’s estate if their estate is valued at £325,000 or less.

There will also be no IHT to pay on the first death of a married couple if a person leaves their whole estate to their spouse or civil partner. When the surviving spouse or civil partner then dies their estate will have an IHT allowance of £650,000. This is called the Transferable Nil Rate Band.

There is also no IHT to pay if a person leaves their whole estate to a charity or a community amateur sport club. There are also various other reliefs and exemptions that apply such as the residence nil rate band and Business Property relief.

An individual whose estate is likely to pay IHT may wish to consider ways in which they can mitigate the IHT potentially due.

The following measures are options potentially available to clients in order to reduce the amount of IHT that their estate may have to pay after their death:-

Gifting money is a very straightforward and effective way to reduce your IHT liability. There are methods of gifting that an individual can do to reduce their taxable estate. These are:-

  • You can give away gifts up to £3,000 in total in each tax year and these gifts will be exempt from IHT. You can carry forward any unused parts of the £3,000 exemption to the following year.

  • Small gifts – gifts up to a value of £250 can be made to as many individuals as you may like in one tax year as long as you have not used another allowance on the same individual who is receiving the gift. Birthday or Christmas gifts that an individual gives from their regular income are exempt from Inheritance Tax.

  • Gifts to qualifying charities – all gifts that are made to a registered charity, political parties, and to certain bodies concerned with the preservation of the National Heritage or for public purposes (e.g. Universities) are exempt gifts from IHT. In terms of leaving your estate to charities in your Will, if you leave 10% of your estate to Charity, your IHT liability will be reduced from 40% to 36%.

  • Regular gifts out of income – you could make monthly or other regular payments which will be exempt from IHT. These gifts must not adversely affect your standard of living and must not be from the capital of your estate. You can make regular payments to help with another person’s living costs. There’s no limit to how much you can give tax free, as long as you standard of living is not adversely affected and is paid from your regular monthly income. These are known as “normal expenditure out of income.” They include paying rent for your child, paying into a savings account for a child under 18 and giving financial support to an elderly relative. It is vital that an individual keeps an accurate record of the gifts they make.

  • Lifetime Gifts in consideration of Marriage or entering a Civil Partnership – you would be able to gift anyone who is getting married the sum of £1,000. A parent can gift their child £5,000. A grandparent can gift their grandchild £2,500 IHT free.

  • Potentially Exempt Transfers (PETs) – In these cases IHT will only become due if you do not survive for 7 years from the date of the gift. If you do survive for 7 years the gift you have made, no matter the sum, will become exempt from IHT.

If you do not survive for 7 years after the gift has been made, the amount of tax payable will depend on the length of time which has passed since the gift was made. The longer you survive, the less IHT your estate will have to pay. The rate of tax is subject to a taper relief system which reduces the rate according to how long you survive since the gift was made e.g. 0-3 years – 100%, 3-4 years – 80%, 4-5 years – 60%, 5-6 years – 40%, 6-7 years – 20%, 7 years – 0%. It is worth noting that the gifts must be outright gifts with no reservation of the benefit from the gift.

  • Trusts –You can gift their assets to a Trust and your appointed Trustees can manage the assets for the benefit of your beneficiaries. There are various different types of trusts depending on what assets you wish to put into a trust and who you wish to benefit from the trust. However, the Trust will require ongoing administration which may incur further costs and the trust may require to be registered in the Trust Registration Service. IHT may be charged at a reduced rate regarding trusts. For most types of trusts, IHT is charged at a lower rate of 20% as at the date the asset was placed into trust this is because most gifts into a trust are Chargeable Lifetime Transfers (CLTs).

  • Life Insurance - You can also take out a life insurance policy to cover any IHT liability and place the policy in trust to ensure the potential IHT liability on your death is paid and covered outwith your estate.

  • Pensions – pensions are a useful way to mitigate IHT liability.  Any person with a large potential IHT liability should consider using their maximum annual pension allowance.

  • Alternative Investment Market (AIM) - AIM is a sub-market of the London Stock Exchange, allowing smaller companies to float shares in their business.  If AIM shares are held in qualifying trading companies for a minimum of 2 years, the shares become eligible for IHT Business Property Relief (BPR) at 100% and are therefore removed from your estate for the purposes of calculating IHT. However, these investments are risky and it is important to go into them knowing this. AIM investments should only be made after receiving investment advice from a qualified financial advisor.

It should be borne in mind that if a gift is made with a reservation of benefit to the donor it will not mitigate their IHT liability. For example, if you were to gift your house, or a share in it, to your family but continue to live there rent free this would not mitigate your IHT liability.

If you wish to discuss any of the above noted options available in further detail please contact our Private Client team at James and George Collie on 01224 581581.

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