Inheritance Tax – how will it affect my family?
Put simply, Inheritance Tax (IHT) is a tax on money, property, savings, investments and possessions you leave behind when you die.
The continued rise in house prices has meant that the number of families paying IHT has grown, with many facing a mounting IHT liability simply because they own a family home that has steadily increased in value over the years.
It’s proving to be a good source of funds for the Exchequer; in 2015-16, receipts from IHT were about £4.7bn, 22% higher than in 2014-15.
With many more people discovering that their estate falls within the scope of IHT, planning your estate to minimise the incidence of the tax makes good financial sense, although this is not always easy.
How does IHT work?
IHT is payable if your estate is worth more than £325,000 when you die, and is payable at 40% (or 36% if you leave at least 10% of you net estate to a charity). Husbands, wives and civil partners (but not unmarried couples) can pass wealth between themselves tax-free while they are alive, and can also inherit each other’s nil rate band on death. This increases the allowance to £650,000 after the surviving spouse dies.
How the family home allowance can help?
This allowance, introduced in 2015, referred to as the ‘main residence nil rate band’ will be introduced in stages over 4 years, with a limit of £100,000 from April 2017, rising to £175,000 per person in 2020. This is in addition to the individual allowance of £325,000.
Once the changes are fully implemented, each parent will be able to leave £500,000 in assets that include a ‘family home’ component of at least £175,000. As allowances can be passed from one partner to another on death, when the first partner dies, their allowance can be transferred to the surviving partner, meaning that they will have an allowance of £1 million. Where the estate is worth over £2 million, the family home allowance (but not the individual allowance of £325,000) reduces by £1 for every £2 of value above £2 million.
Making gifts during your lifetime
With more and more parents and grandparents looking to pass on wealth to family members during their lifetime, it’s important to be aware that these gifts of money can potentially attract IHT. Under what’s referred to as the ‘seven year rule’, gifts made during a donor’s lifetime can be totally exempt if they survive for seven years after making the gift. If death occurs within this timeframe, IHT may become payable, although taper relief could apply following the third year after the gift was made, and each subsequent year up to the seventh.
The operation of this rule can be particularly complex where property is concerned; property cannot be deemed a gift if you intend to continue living there, and there could be capital gains tax implications for the beneficiaries if the house was not their main residence. It’s also important to note that the sale of a property to a beneficiary at a reduced price would create an IHT liability, with the difference between the price paid and the market value viewed as a gift for IHT purposes.
Other ways to reduce your IHT liability
There are a number of allowances that can be used to reduce effects of IHT. You can make gifts of up £3,000 (in total, not per recipient) plus any number of gifts up to £250 per other recipient during each financial year.
Weddings represent another opportunity to hand money on. Before the wedding day, each parent of a bride or groom can give up to £5,000; grandparents or other relatives can give up to £2,500 and any well-wisher can give £1,000.
If you’re in the fortunate position to be able to do so, consider making regular gifts under the ‘surplus income exemption’. This enables you to make a series of gifts from your spare income free of IHT, although strict record-keeping applies.
Everyone’s circumstances are unique and tax planning is a highly complex area; if you’d like some advice on how to reduce the impact of IHT on your estate, do get in touch.