Inheritance Tax (IHT) is the tax paid on the estate of a deceased person and is sometimes, rather coldly, referred to as the ‘death tax’.
When a person dies the value of their assets (known as their estate) is assessed and tax is paid (by the estate) before the deceased's beneficiaries receive their gifts.
There is an individual threshold of £325,000 which means that assets up to this value will not (normally) attract any Inheritance Tax.
Assets above this value are currently taxed at a rate of 40% although there is no IHT to pay when assets are passed to a spouse or civil partner, regardless of value.
For married couples and those living in a civil partnership, the individual allowances can also be combined giving a joint allowance of £650,000 and the surviving partner is also able to carry the deceased's allowance over for use in their own estate.
There are several ways in which Inheritance Tax liabilities can be reduced including things such as passing assets to charity (even a partial gift can reduce the overall rate paid by the estate) or to community amateur sports clubs.
It is also worth noting that if you pass a house to your children or grandchildren, your tax-free threshold can be increased to £500,000 (rules apply).
Reducing the amount of Inheritance Tax that your estate will have to pay is something that needs to be planned for and often actioned well in advance and in this blog, we will be looking at the area of gifting money and/or assets to loved ones in order to avoid IHT.
As an individual, you can give away up to £3,000 in each tax year without incurring any Inheritance Tax. Although this is a relatively insignificant amount in terms of a single year, it can naturally build to a serious amount of value over time - so the earlier you act, the better.
If you have assets such as cash, jewellery, and investments that you do not need to rely on in retirement, then ensuring that you gift the maximum £3,000 each year is a quick and easy way to reduce IHT liabilities.
Please note that gifts of this nature must be correctly recorded - contact us for more information.
One little-known aspect of gifting is that individuals can also gift as much money as they like provided that it comes from their income, and not from existing assets - known as ‘gifting out of surplus income’.
As more and more families are finding themselves subject to Inheritance Tax this is a much-overlooked tax exemption that may be an option for them - in fact, a Freedom of Information request revealed that only 430 families used this rule last year.
The rules must be properly understood and applied, but in essence, an individual can pass on unlimited wealth to their loved ones free of inheritance tax - as long as the gifts do not diminish their quality of life and the money comes out of income, not capital.
It is a very straightforward mechanism to set up with no need for things such as trusts.
Crucially, these gifts are not subject to the seven-year rule.
What counts as income?
Provided that you can afford the gifts after paying your normal outgoings and there is no adverse impact on your standard of living, then income received from dividends, pensions, employment and rent can all qualify.
With interest rates finally back to more sensible levels, gifting from interest on savings is also proving increasingly useful.
One important aspect is that the gifts should be regular and HMRC will look for a ‘pattern’ (typically over the previous three years or so) to help establish if the gifts are ‘normal’ and provided on a regular basis.
The tests around regularity also include looking at the amounts involved, so you should try and ensure that each gift is for around the same amount.
What do I need to do?
The most important thing is to keep very clear records of income and expenditure and to ensure that these will be available to the executors of the will.
It is the executors that will make the relevant claim with HMRC once they have calculated the deceased net income, after expenditure, which is why taking advice around establishing an appropriate level for regular gifts is vital.