Although it affects relatively few people, about £1.4bn too much inheritance tax is paid each year, according to research from advisers’ body, IFA Promotion.
There are three main taxes that affect most people: income, capital gains and inheritance. The good news is that most people do not pay inheritance tax, in his 2005 budget, Gordon Brown claimed that 94% of estates avoided it. But it is an area that is now concerning far more people largely because of rising property prices. Many people now own valuable homes, and their total assets exceed the inheritance tax threshold.
What if I leave everything to my husband or wife?
No inheritance tax is payable, but you must both be domiciled in the UK.
What’s the inheritance tax threshold?
The current nil rate band is £325,000.
The rules are that if you are married and your spouse did not use their allowance on death that is can be carried forward therefore an allowance of up to £650,000 may be available for married or civil partnered couples.
Anything over the threshold will be taxed at 40%. The sum up to the threshold is known as the nil-rate band.
What deductions are made?
Bequests to a spouse and UK charities are exempt, and outstanding bills, together with funeral costs, will also be deducted from the inheritance tax amount outstanding.
Who pays the tax office?
This will be paid by personal representatives – typically, any children. In some cases, children or heirs can find themselves having to pay the tax bill out of their own funds. Some people find themselves forced to take out bridging loans to meet tax liabilities because they are in the process of disposing of assets, which is why planning before you die can be very helpful.
When is money owed for inheritance tax payable?
It needs to be paid six months after the end of the month when the person has died. The authority to release the money held in the estate is known as probate in England and Wales and confirmation in Scotland.
How can I avoid paying inheritance tax through gifts?
The crucial issue with making gifts is that they are made seven years before you die – it is, in a sense, a clock ticking when you can beat the tax office.
What are the rules concerning gifts?
Although gifts made in the seven years before your death can be subject to inheritance tax, a number are exempt from tax. A list of these can be found in An Introduction to Inheritance Tax, a leaflet available from the Inland Revenue. These gifts include: sums of money of up to £5,000 given as wedding gifts to children; maintenance payments to ex-partners and children; and other gifts of up to £3,000 made during a tax year.
Everyone has this £3,000 limit and, if it is not used up in one year, the amount can be carried forward to the next. Small gifts of up to £250 can be made to any number of people.
The situation concerning gifts can be complicated and, again, it is an area where many people will want to seek advice from an experienced financial adviser.
What are “potentially exempt transfers”?
It is just another term used for gifts made within the seven-year period to friends and relatives. If you die within the seven years, the value is added to your estate and tax will be payable on whatever exceeds the threshold; if you do not, then the gift is exempt. You do not have to tell the tax office about gifts you have made, but the recipient is required to report the gift within a year of the donor’s death.
If the death is within three years, the recipient must pay 40% tax on anything over the threshold; after this, a sliding scale is applied. This is equivalent to a reduction by a fifth of the tax payable if the gift was made between three and four years before your death; another fifth if between four and five years; and so on, until the seventh year when the gift becomes totally exempt.
Note that in the tax year, 2006/07, if you give a gift of £200,000 and die within three years, the recipient will not have to pay tax, but your estate will be charged 40% on anything over £85,000.
What are chargeable transfers?
Although there is no inheritance tax charged on a gift made after surviving for at least seven years, chargeable transfers can incur tax. These are sums of money transferred typically to trusts for which tax payable at 20% is normally levied on the excess above the threshold.
These can also be known as discretionary trusts, which are administered by trustees and where the individual may have no immediate right to income. Gifts to companies are also known as chargeable transfers.
What about giving away a property?
Giving away your home to children or relatives will not mean you are automatically exempt from inheritance tax. If you plan to keep living in it, you need to prove you are paying the new landlord the correct market rent. The landlord could also face a capital gain tax bill when the property is sold and the inheritance tax sum owned if you die within seven years of making the gift.
What about insurance policies?
Many people have life insurance and if you die and the proceeds are paid into your estate, it could cause your estate to exceed the limit. The way around this is to have the policy within a trust. Pension fund proceeds passed on to a spouse or charities will be free of tax.
What about gifts to charity?
Anything left to a UK charity is free of inheritance tax and this also applies to political parties and housing associations.
What about a trust to avoid inheritance tax?
Trusts are a good way of avoiding or paying less inheritance tax and a financial adviser can assist with setting these up. They are not necessarily a total escape from tax though – dependants may still face a tax bill, although at a lower rate of 20%.
Financial products are held within trusts and are typically provided by insurance companies. It is worth noting that some have higher charges than others.
You will need advice on how to set these up. Graham Collins of Advisory & Brokerage says: “These are best viewed as a way of giving away ownership of money, but still retaining some measure of control.”
If you do not set up a trust, although you can transfer assets to a spouse tax-free, when they die and pass on wealth to the next generation, inheritance tax will be payable on everything beyond the limit.
Life insurance can be written in trust. This applies mainly to “whole of life” policies. In the case of married couples, for example, a policy would be written on both lives, which pays a death benefit on the second death – when inheritance tax issues would arise.
You can also buy a policy called a “gift inter vivos” – meaning a gift between two living people – which is also written within a trust. This is a temporary type of cover, aimed at meeting the inheritance tax liable if you die within seven years of making a lifetime gift. The death benefit will reduce as the potential tax liability reduces.
Posted on October 20, 2017