The taxman enjoyed a record £5.4 billion of inheritance tax receipts in the last financial year: an increase of 3.1% on the previous year. Insurer Canada Life predicts this figure will grow to £10 billion by 2030 as a result of the stagnant nil-rate band which isn’t keeping pace with inflation.
Whilst the £325,000 allowance might once have seemed generous, it is hardly sufficient now when the average house costs £472,230 in London, £321,174 in the South East and £288,494 in the East of England.
Fortunately with proper advice and a little careful planning, inheritance tax liability can be reduced. The main allowances to be aware of are as follows:
Basic IHT allowance
Everyone gets the nil-rate band which is currently £325,000 and unlikely to increase any time soon. Anything falling outside of that amount is taxed at 40%. However, if you’re married or in a civil partnership, you can pass everything to your survivor without any liability, leaving your full allowance in tact. This allowance can be claimed by their estate on their death and this is dealt with as a percentage uplift.
Careful thought should be given as to whether this strategy is appropriate for your circumstances. For example, if you leave everything to your partner and they then need care after your death, the full value of the estate down to a lower limit of £14,250 will be available for care fees. Further, if they remarry, their new spouse will be first in line to inherit over your children. There are various strategies to mitigate these issues which should be discussed with an estate planning solicitor, such as leaving a life interest in the family home.
Residence nil-rate band
The Residence Nil-Rate Band (RNRB) is an additional allowance of £150,000 which applies where you leave the family home to a direct descendant. This allowance will increase to £175,000. Like the basic allowance, it can be transferred if not used – so if you leave everything to your spouse or civil partner, their estate can claim the unused allowance on their death, provided that they leave the family home to direct descendants.
The combination of the basic £325,000 allowance and additional RNRB currently allows couples to leave up to £950,000 to their direct descendants free of inheritance tax (£1 million from next year).
Purchasing a life insurance policy is a sensible decision where you have dependants – but did you know its value can be passed on completely free from inheritance tax if you write it into trust? This simple step puts the policy outside of your estate and ensures the 40% IHT charge does not apply.
It is not uncommon for people to try and reduce the value of their estate before their death, to avoid IHT. However, be aware that generally you will need to survive for 7 years before the gift is excluded from the value of your estate for inheritance tax purposes. There are a number of exceptions to this.
You can give up to £3,000 a year without any inheritance tax becoming due. If you didn’t give anything the previous year, you can ‘roll over’ that year’s allowance too. So, for example, a couple who didn’t gift anything in 2018 can together give £12,000 in 2019 without any IHT implications.
In addition you can give as many gifts of up to £250 in value per person as you like. You can also gift your child £5,000 for their wedding (£2,500 if they are a grandchild or £1,000 for anyone else).
A further valuable exemption is for gifts made out of income. You can regularly gift money out of your excess income of any amount, provided that it does not affect your standard of living. There is no limit on the value of such gifts, although you should keep meticulous records so that the exemption can be claimed if needed.
If you leave money in your pension when you die, this is usually free from IHT. In addition, if you die before 75, there is a further benefit – the beneficiary will not usually pay income tax on withdrawals. If you die over the age of 75, income tax is payable on withdrawals at the beneficiary’s highest marginal rate (so for example if they are a basic rate tax payer, withdrawals will be taxed at 20%).
There is a generous pension allowance of £1,055,000 this tax year which is a substantial sum to pass on tax free. However, take care – if you are in ill health and start paying large amounts into your pension, HMRC may challenge the exemption.
For most people, when you consider that IHT is usually payable on the investments and ISAs that you leave, it may be better to cash in other investments before withdrawing money from your pension.
Consider your beneficiary
Leaving large sums to beneficiaries free from IHT might seem like the most desirable outcome here – but consider your beneficiary. If you leave a £1,055,000 pension to a beneficiary whose assets already exceed their inheritance tax allowances, their estate will become liable for the tax on death. If they try to mitigate this by giving the asset away, the seven year rule applies – otherwise IHT of up to 40% becomes payable.
This can be mitigated by drawing up a Deed of Variation within two years of your death, so that the asset is treated as if it were let to someone else.
Speak to our later life planning team about inheritance tax planning: call us on Southport 01704 532890 or Liverpool 0151 928 6544, or complete a Free Online Enquiry and we will soon be in touch.