More people are becoming liable for inheritance tax (IHT) each year, largely thanks to the increase in property prices over the past few years.
The first £325,000 of your estate is exempt. You can also pass on an additional £175,000 tax-free amount if you pass your main residence on to your children or grandchildren. This gives many people a total tax-free allowance of £500,000. Anything left to a spouse or civil partner is IHT-free and they can also inherit any unused allowance. This doubles the amount a couple can pass on to a direct relative tax-free to £1 million. The additional £175,000 nil rate band falls by £1 for every £2 a couple’s estate is worth over £2 million, however. Anything over the IHT allowance attracts a tax rate of 40 per cent.
If you believe your estate will attract IHT, with a little planning, it is possible to give away some of your estate by using exemptions and other measures, without worrying about landing your family with a tax bill after you die.
Each tax year you get an annual exemption that allows you to give £3,000 as a gift, tax-free, without HMRC adding it to the value of your estate for IHT purposes.
You can also carry over (for one tax-year only) any annual exemption from the previous tax year. That means a couple can give away £6,000 in a year, or £12,000 if the exemption wasn’t used the year before.
You can give as many gifts of up to £250 per person as you want each tax year, as long as you have not used another type of gift allowance on the same person.
You can give your child a wedding or civil partnership gift of £5,000, or £2,500 to a grandchild or great-grandchild. For anyone else it’s £1,000. You can give these gifts on top of your annual £3,000 exemption in the same tax year.
The seven-year rule
You can give away all types of assets — including cash, property, and shares — tax-free, as long as you live for seven years after making the gift under what are known as potentially exempt transfers.
If you die within seven years, the recipient of the gift will have to declare it as part of your estate and HMRC may demand tax on it. The amount of tax due will depend on how long you lived. If you die between three and seven years after making the gift (and it brings the estate over the £325,000 threshold) then you pay tax on a sliding scale. In the fourth year after, the charge is 32 per cent, in the fifth year it’s 24 per cent. It falls to 16 per cent for the sixth year and 8 per cent for the seventh.
Gifts from income
You can give away unlimited cash without falling foul of the seven-year rule as long as it’s from surplus income and doesn’t reduce your standard of living or force you to dip into your capital to cover day-to-day costs.
If you want to set aside money for your family further into the future, you could set up a trust to minimise inheritance tax.
You will need to speak to a solicitor or other expert to ensure that you set up the right type of trust (there are several) for your family’s needs.
With all of the above, it is vital that you keep records as your executors may need to provide these to HMRC when administering your estate.