Having recently moved house and also reviewed my end-of-year portfolio and finances, this is probably a good time to expand on some brief notes I made on inheritance tax.
Whilst many pensions are usually exempt from inheritance tax, the total value of any house, cash or investment ISA will form part of your estate and is therefore liable to 40% inheritance tax (IHT) on death. For most people, it's not an issue as their estate is valued well below the threshold. However, as the value of property such as your main residence or buy-to-let properties and also (hopefully) investments rise over the years, it will pay to be aware of the potential liability for inheritance tax as the value of such assets rises over £300,000.
Currently only around 1 in 20 people become liable
for inheritance tax but given the rise in property prices, particularly in
London and the South East, it is very likely that more people will become
liable to the 40% tax in future.
The
Basics
IHT, otherwise known as the Death Tax, only kicks in
when you die.
There is nothing to pay if your estate - i.e. the
value of everything you own - is:
1. Less than £325,000
2. You leave everything over this figure to your
spouse/civil partner or a charity.
If neither of the above applies then your family will pay 40% IHT on the value of the estate
above £325,000. So, if the estate is valued at £500,000, your estate pays the
taxman £70,000 (£500,00 - £325,000 is £175,000 x 40%). Any tax due must be paid
6 months after the date of death.
Main
Residence Allowance
If you own your main residence and you are leaving
this to children or grandchildren, then you will get an additional 'main
residence' allowance of £175,000 (currently) added to the £325K which means
that up to £500,000 would be tax-free for estates worth less than £2 million.
So, in the above example, if the estate was left to
children/grandchildren and included a main residence then instead of a £70,000
tax liability, no IHT would be due.
A married couple including civil partners can currently leave
up to £1 million tax-free as the surviving spouse can use the deceased
partner's allowance - £500K if there's a house involved which is common.
Gifts
You can make a gift of up to £3,000 each year to
anyone free of tax. In addition, you can make a wedding gift of up to £5,000 to
children and £2,500 to grandchildren and £1,000 to others tax-free.
Beyond this, you can give any amounts to family or anyone else but such gifts are regarded as potentially exempt transfers under the seven year rule.
The 7 Year Rule on Gifts
Money or other valuable assets given away before
death will still be counted as part of your estate but are regarded as
potentially exempt transfers. If you survive for 7 years or more after the
transfer then it becomes exempt from IHT. There is a sliding scale of tax due
for gifts made less than 7 years before death. Within the first 3 years it will
be 40% and then reduces by 8% each subsequent year.
Pension
In the past, pensions were taxed at 55% on death however this changed in 2015. Now, much will depend on
the type of pension and also the age when you die.
With SIPPs and income drawdown plans, the 55% death
tax has gone and now the beneficiaries will pay no tax if the pension holder
dies before age 75 and after that age, they pay tax at their notional
rate...usually 20%.
However these new rules do not apply to final salary
schemes - also known as defined benefit - which provides a guaranteed income
for life and then a reduced pension for a spouse or civil partner.
Shares
Listed on AIM
The value of most (but not all) shares listed on the
Alternative Investment Market or AIM will be exempt if held for at least two
years prior to death. This is because the assets qualify under the provisions
of Business Property Relief (BPR). For example, I currently hold shares in ITM
Power and Ceres Power which are both listed on AIM so their value would not
count as part of my estate provided I had held for at least two years.
Under the same BPR provisions business owners may well qualify for exemption from IHT on the value of their business, including shares in their business if a limited company, provided they were the owner of the business for at least two years prior to death.
Life Insurance and Trusts
Finally, it is possible to reduce or mitigate liablity for IHT by setting up a trust or taking out life insurance.
The basic idea is that some of your assets are given to the trustees via a trust deed for the benefit of others (beneficiaries) such as family members. The property is then held in trust and does not form part of your estate on death. It can be expensive to set up and administer a trust over many years and also, once the assets are transferred to the trustees, it usually cannot be reversed.
Likewise, if a life insurance policy is written in trust, the payment made on death will not become part of your estate but can be paid out directly to your spouse or other beneficiaries.
In the above cases it is advisable to seek specialist
help from an IFA, tax advisor, insurance specialist or solicitor.
Conclusion
Some people who have been lucky to accumulate assets
in excess of half a million pounds during their lifetime may well not have a problem seeing some of
it pass to the taxman after they have gone. After all, our governments are
under increasing pressure to pay for our NHS that has served us so well as a
nation during the Covid pandemic as well as repaying all the debts - estimated additional £350 billion -that have
been accruing over the past year due to paying the nation to stay at home.
Others believe that having worked hard and paid a
lot in taxes and national insurance over many, many years, they draw the line at
paying a further 40% when they pass away.
I can actually see both points but for the time
being it's academic and I do not have to make a choice...but will be keeping an eye on property
prices and my investments.
If you have any views in IHT or have taken steps to
mitigate future liability, feel free to leave a comment below.
Great article, one thing I think worth adding........many people think that if you give your child money say £20000 as a gift and then die, that the child will have an IHT liability, but it’s important to state that they only have a liability if you die leaving more than the IHT allowances. If you don’t have more than the allowances to leave when you die then there is no IHT liability for your children. So you can safely give your children more than the £3000 gift allowance each year you are alive without any IHT impact as long as your total wealth is under the IHT allowances
ReplyDeleteYes, that's a good point Rozentas. All gifts over the £3,000 annual allowance would be classed as potentially exempt transfers but IHT liability would only apply for those estates valued at over £325K.
DeleteAlso you are allowed to give £250 per year to any number of people and this will not affect IHT.
ReplyDeleteFor instance, we have three children (grown up with their own families). My wife gives then £1,000 each on their birthdays and I give them £1,000 each at Christmas. This uses up the £3,000 allowance for me and my wife. I then give the 6 grandchildren £250 each at Christmas and my wife gives them each £250 on their birthdays. I believe all these gifts are exempt
Thanks for expanding on the gifts allowance thinker. You are quite correct that a total of £3,000 can be given away tax-free every year. In addition you can give up to £250 to as many individuals as you want but NOT including those in receipt of the £3,000. So, gifting £3K between your children each year and £250 to each of the grandchildren would appear to be a good plan to mitigate any IHT liability.
DeleteIt's probably a good idea to keep a careful record of these gifts should there be any queries from HMRC in the future.
A useful summary, thanks. Something to think about.
ReplyDeleteI'm one of Inheritance Tax's fans. I want the things that tax buys, the government need to take the money from me at some point. On my death bed I have the least need for money, it's the ideal time for me to pay the bulk of my tax bill. If I had the option of delaying all my tax until the end of my life that would be event better.
ReplyDeleteOn the receiving side, no-one is required to give me anything after they die. So 60% of something is still more than I deserve or need. Again, alongside an unexpected windfall is an ideal time for me to be throwing more in the pot to pay for all the things that tax buys.
I think there will be lots of people who share your general view on this tax PwF. I was just thinking of all the taxes we pay in the UK...obviously income tax and national insurance as well as council tax, 20% VAT on almost everything we buy, stamp duty on a property purchase, fuel duty, insurance premium tax, duty on tobacco, alcohol and betting, stamp duty on our share purchases...then there's corporation tax and business rates...probably adds up to quite a lot over a lifetime!
DeleteWhich is why a lot of people take the opposite view and want to pass on whatever they have managed to accumulate.
I would be interested to hear what other readers think.
I am with Playing with Fire on this one.
DeleteMost of us expect the Government to pay for our health care, defence, policing etc and this of course can only come from tax. As PwF states the time anyone is least in need of money is on their death bed, so I see any inheritance tax as a reduction on other taxes. Also as pointed out by PwF a value of £325k is tax free and then 60% of the remaining estate is left after tax, and a huge amount of people (me included) think anyone who has an estate in excess of £325k is in a reasonably fortunate position (and I luckily fall into the group that has over £325k when my home is included so my estate will be liable for IHT unless the value gets whittled away due to care costs as I get older).
If we don't like IHT, then we need to either lower our expectations of what we expect from the government, or agree to higher / additional taxes on other areas.
A tax that only applies to 5% of the population, and that the 5% who it does apply to are at the wealthier end of society seems to attract a high proportion of opposition, perhaps this is because a large number of people in the media fall into the 5% and are therefore more personally motivated to oppose it and use their position to publish their opposition.
You can also give regular gifts from surplus income providing you can prove it does not affect your standard of living. The gifts must be regular, and you have to keep extensive records of your annual expenditure to prove the gift is from income and not savings.
ReplyDeleteYes, definitely keep careful records of any gifts if there's any possibility of becoming liable for IHT.
DeleteHMRC have form IHT403
ReplyDeletehttps://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/917890/IHT403-05-20.pdf
Page 8 details the information needed to substantiate a claim for gifts out of surplus income.
Yes, can confirm above having dealt with my late mother's estate. On the advice of a financial advisor she consolidated old accounts and bought an AIM portfolio, set up a "gift trust" which would be out of IHT in 7 years, and made gifts to her children of unspent income (until the point when she needed to go into a care home, which greatly increased her outgoings).
ReplyDeleteThe IHT efficiency worked. I had to declare every share in the AIM portfolio separately (and it needed plenty due to risk of under-diversification) and I had to present summary statements of her income and expenditure (a bit of a pain, but helpfully she had been in the habit of reconciling her monthly bank statements and making pencil notes explaining items). The gift trust was more of a pain though: although conveniently being totally outside her estate thus not even needing declaring, it had all sorts of processes and rules of its own that weren't apparent when its IHT advantage was promoted. You need to consider the tax gain against what in Brexit terms would be called "non-tariff barriers" like needing to establish each beneficiaries' available tax threshold from "top-slicing" before distribution.
Jonathan
That's an interesting practical example Jonathan and thanks for sharing and emphasising the need for keeping careful records.
DeleteI believe the additional nil rate band for a primary residence is also retained if you sell the property before you die "The additional nil-rate band will also be available when a person downsizes or ceases to own a home on or after 8 July 2015". This means you can sell up and rent, for example to live nearer family members, without losing the IHT benefit from your previously owned home.
ReplyDeleteThanks Ian. I think your broad point is correct but it can get a bit tricky when someone may down size to a property valued at less than £175,000 for example or what if the property reduces in value after the move?
DeleteAlso there are complications if part of the estate is left to children and part to say a brother or sister.
For those who may wish to delve further, here's a link to the HMRC guide...
https://www.gov.uk/guidance/how-downsizing-selling-or-gifting-a-home-affects-the-additional-inheritance-tax-threshold#downsizing-to-a-less-valuable-home
Nice summary, and useful comments too.
ReplyDeleteMy understanding of the sliding scale for tax on gifts within the last 7 years is that it only applies to any gifted amount(s) over the £325k allowance:
https://www.gov.uk/inheritance-tax/gifts
Yes, I think this is a similar point to that made by Rozentas in an earlier comment. IHT only applies where the value of the estate is above £325K.
DeleteYou misunderstand what Anonymous is saying...
DeleteThe sliding scale of tax rates on gifts (tapering I think they call it from memory) that may apply to gifts within 7 years of death, ONLY applies if the gifts exceed the available nil rate band. So as the majority of gifts are under the NRB in most cases the tapering does not apply and you end up paying 40%. This is a suprise to most people and is not made clear in your article.
Example: single person wealth of 700k with Nil Rate Band of 325k. Makes gift of 300k and then dies 6 years later. Ignoring the RNRB for simplicity. From your article, and many newspaper articles, you might think think that you would pay a reduced/tapered tax on the 300k and that most of the rest of the wealth would be protected by the NRB. But that's not how it works. In fact the gifts are subtracted from the NRB first, and as they are fully covered by the NRB there is no tax on the gifts and therefore no tapering. But that then leaves only 25k NRB for the rest of the estate, worth 400k (700k - 300k). So 375k (400k - 25k) is taxed at 40%.
If instead the gifts had been 400k then they would have used up the whole of the 325k NRB and the excess 75k would have received a tapered tax rate. Then the remainder of the estate of 300k would be taxed at 40%. Less tax overall is paid than the original example because 75k received a tapered tax rate, but the overall saving is modest because it's only a small amount of the 400k gift.
John
John
DeleteThanks for clarifying the taper rule. I had a total misunderstanding of how it was applied.
The money advice service have a simple description of its application
www.moneyadviceservice.org.uk/en/articles/gifts-and-exemptions-from-inheritance-tax#what-is-a-potentially-exempt-transfer
Colin
Thanks John, that is indeed a separate point to that made by Rozentas. Thank you for the excellent clarification!
DeleteI guess this begs the question, given your estate is valued over £325k as a single person ignoring the residence allowances, then how long before you die can you give a gift and not have it counted as part of your estate. So an an example if I am 60 and I give a gift of £50k to my son and don’t die til I am 90 would the revenue still count the gift...........how far back do they expect records to be kept?
DeleteRozentas
ReplyDeleteGifts are not counted towards the value of your estate after 7 years.So if you live more than seven years from when you make the gift, your son won’t have to pay Inheritance Tax on the gift when you die.