For many parents and grandparents, inheritance tax (IHT) is perceived as being unfair.
Why should the natural action of passing of assets to children and grandchildren trigger a tax charge? The rapid growth in UK house prices — particularly in London and south-east England — experienced in the recent past, has resulted in IHT impacting many people on relatively modest incomes.
Whatever the inequities and illogicalities in the current IHT system we at Framling Wealth are committed to reducing its impact on your family. How much does IHT raise?
In 2019/20 IHT raised £5.4 billion; receipts are forecast to be £5.5 billion in 2020/21. How does the tax work? Inheritance tax (IHT) is charged on the value of a person’s “estate” (net assets) at the time of death. When calculating the taxable value of a person’s estate, gifts made within seven years of death are included.
An individual might make a gift but retain a benefit from the gifted asset. One common example is where a parent gifts a house to a child, but continues to live in it as before, rent free. This type of gift is called a ‘gift with reservation’. Gifts with reservation are included in the taxable estate. Certain gifts are exempt from tax regardless of size, and irrespective of whether they are made during lifetime, or on death under the terms of one’s will. These are:
- Gifts to a spouse or civil partner.
- Gifts to charities.
However it should be appreciated that a gift to a spouse or civil partner merely defers IHT; the gifted assets become part of the recipient’s estate and will potentially be subject to IHT on a later death.
Some gifts are ‘exempt’ regardless of when made. The most common are:
Gifts made during one tax year of a total not exceeding £3,000. This allowance can be carried
forward for one year.
Any number of individual gifts, worth up to £250, made during the year to different persons
(this relief is in addition to the annual allowance of £3,000).
Gifts, up to a specified maximum, given to the bride or groom, in consideration of marriage.
Other gifts which do not fall to be treated as exempt when made may be “potentially exempt transfers” (PETs) and be exempt from an immediate tax charge. PETs become fully exempt if the person making the gift lives for at least seven years after having made it.
There are important reliefs in respect of business and agricultural assets, and as a consequence bequests of businesses and farms is usually free of IHT.
Rate of tax
The tax is charged at 40% above a tax-free threshold, currently £325,000. This is known as the nil-rate band.
Widows, widowers and civil partners are entitled to use the share of their partner’s nil-rate band which was unused on the first death.
An additional nil-rate band applies on transfers, on death, of a main residence to a direct descendant.
Planning
The logical way to reduce exposure to IHT is to reduce the size of the estate on which the tax is levied. This can be done by making lifetime gifts, taking advantage of the various exemptions available and the PET rules. It is also possible to use a special type of life assurance to protect against the IHT consequences of death within seven years of making a gift. Gifting strategies might not always be simple to implement. Who is to receive such gifts? Will gifting reduce our client’s ability to enjoy their hard earned wealth? The use of trusts can help solve some of these problems. It is also possible to invest in assets qualifying for business or agricultural relief – currently at a rate of 100%.
Where neither gifting nor investment in assets qualifying for relief are appropriate, it is possible
to use life assurance, in a suitable trust structure, to fund the IHT liability. Client’s circumstances differ so we undertake a thorough analysis of assets and transfers to establish the exposure to IHT and then undertake a discussion as to how our client wants those
assets to devolve to their family. Only then do we consider specific planning strategies.