23 Oct 2017
Author: Stephen Breen
It’s likely you’ll have heard or read recently in the news that Hugh Grosvenor, the only son of the late Duke of Westminster Gerald Cavendish Grosvenor, inherited the bulk of his father’s £8.6 billion estate free from inheritance tax – a feat achieved through the use of family trusts. The news has led to calls for reform of inheritance tax rules.
Trusts are often viewed as a way for the wealthy to avoid their assets being taxed on death. There may still be an inheritance tax liability, however – the Grosvenor Estate remarked that the trust paid inheritance tax at the rate of 6% every 10 years to HMRC, noting:
“the actual amount paid to HMRC over the life of the trust is pretty much equivalent to a single payment on the death of the beneficiary of the trust. The business assets of the Grosvenor Estate are held in trusts to maintain continuity of ownership between generations and not to avoid inheritance tax.”
The Office for Budget Responsibility have noted that the increase in revenue from Inheritance Tax has due to asset prices. Residential property makes up the largest share of most estates and average house prices have risen sharply, whilst the inheritance tax threshold has remained the same. So how can you avoid paying more inheritance tax than you need to? We look at the main allowances and exemptions, together with ways you can reduce your inheritance tax bill.
Inheritance tax allowances
Everyone has an inheritance tax allowance of £325,000. The new Residence Nil Rate Band (RNRB) increases this allowance if you are passing on a family property. The RNRB is being rolled out incrementally, as follows:
- £125,000 in 2018 to 2019
- £150,000 in 2019 to 2020
- £175,000 in 2020 to 2021
Therefore if you die in the year 2020 – 2021 you could pass on up to £500,000 to beneficiaries of your choice, without your estate being liable for inheritance tax.
If you pass everything to your spouse/civil partner, this is free from inheritance tax and your £325,000 allowance plus any RNRB goes unused. These allowances can be transferred to your spouse/civil partner, allowing them to leave a higher amount to beneficiaries of their choice. For example if you died in 2020/21 and your spouse died some years later, they could leave up to £1,000,000 to their beneficiaries free of tax.
Gifts to charity do not come out of your inheritance tax allowance.
Business property can also attract allowances or exemptions, if it is owned up to two years immediately before death.
100% will be disregarded in respect of:
(a) a business, or an interest in a business (such as a share in a partnership); and
(b) unquoted shares.
50% will be disregarded in respect of:
(a) quoted shares which gave the transferor control of the company; and
(b) certain land, buildings and machinery owned by the deceased that was used in their company or partnership.
Pensions can also be free from IHT. If you die before the age of 75, there is no IHT to pay, and no income tax when your choice of beneficiary starts to draw money from your pension pot. If you die at 75 or after, there is still no IHT to pay but your beneficiary will be taxed at their highest marginal rate when drawing income from it. For example, if they’re normally a higher rate tax payer, any withdrawals will be subject to 40% tax.
Gifts made within 7 years of death will count against your allowance. So, for example, if you make a gift of £100,000 a year before your death, your allowance for inheritance tax purposes will be just £225,000 plus any RNRB. If the gift is made between 4 and 7 years before your death, the rate of inheritance tax charged is tiered.
For gifts made between 4 and 7 years before your death, the rate of inheritance tax is tiered as follows:
- Gift made less than 3 years before death – 40%
- Gift made 3 to 4 years before death – 32%
- Gift made 4 to 5 years before death – 24%
- Gift made 5 to 6 years before death – 16%
- Gift made 6 to 7 years before death – 8%
- Gift made 7 or more years before death – 0%
There are however some allowances for gifting during a person’s lifetime, as follows:
(a) The annual exemption
The annual exemption applies to the first £3,000 you gift in each tax year. Any unused annual exemption may be carried forward for one year only, so that a maximum exemption of £6,000 may be available. If for example, you gave your daughter £6,000 just before your death and made no other gifts within the previous seven years, this would not reduce your inheritance tax allowance as it would be caught by the annual exemption.
(b) Small gifts
Small gifts of up to £250 to any one person in a tax year are also exempt.
(c) Normal expenditure out of income
Additionally, normal expenditure out of income is exempt provided that after the payment was made, the person making it was left with sufficient income to maintain their usual standard of living. This would allow, for example, a parent to help with a son or daughter’s regular bills, without any inheritance tax implications.
(d) Gifts in consideration of marriage
Gifts made in respect of a marriage are exempt up to:
(a) £5,000 by a parent of a party to the marriage; or
(b) £2,500 by a remoter ancestor of a party to the marriage (such as a grandparent); or
Inheritance tax rates
Having applied all of the above reliefs and exemptions, inheritance tax is charged at 40% on everything above the person’s allowance (£325,000 plus any RNRB, plus if their spouse/civil partner died first, any allowance that went unused). Occasionally if a person leaves 10% of their estate to charity, the estate may instead pay a lower rate of 36% tax.
What about trusts?
Trusts can be used to cut your inheritance tax bill but this is an immensely complex area of law outside the scope of this article Professional advice should be sought to determine if a trust would be appropriate in your circumstances.
The above rules show that there are many ways to reduce any potential inheritance tax liability including:
- Making use of your inheritance tax allowance (£325,000 plus the new RNRB)
- Passing your assets to your spouse / civil partner (thereby also giving them your unused inheritance tax allowance)
- Making gifts within your annual allowances (or above if you are relatively confident that you will survive for the next 7 years)
- Making gifts out of income, provided that they do not affect your standard of living – it is advisable to keep good financial records to assist your Executors on proving this point
It is however important to note that you cannot gift something and retain the benefit of it to avoid inheritance tax. For example, if you gift your home but continue to live in it, it will still count towards the value of your estate for inheritance tax purposes.
Inheritance tax is complex and the above is intended to be a general guide. It is important to take professional advice based on your circumstances. Speak to our later life planning team about arranging your affairs to ensure that you don’t pay any more tax than you need to.