Inheritance Tax (IHT) has garnered much attention in the press of late. This came to a head around the time of the recent Autumn Statement, when we heard many rumours about it being axed. However, for now at least, it’s here to stay. It is something you must consider if you are serious about passing on part of your wealth to the next generation.
Inheritance Tax in a nutshell
Inheritance Tax is paid upon an estate of someone who has died and is calculated on all your assets. This includes property, investments, bank accounts, and so forth. It does, however, exclude pensions. You would pay IHT at a rate of 40% on anything over the Nil Rate Band (NRB) of £325,000.
It does not apply to all estates, but you do not have to be rich to fall into the IHT bracket. The NRB threshold has not changed since 2009 and will remain frozen until 2028. When we consider the impact of rising costs and inflation, and the price of property on its own, it is easy to see how many of us could easily creep into the eligible column without realising it.
The NRB allowance is transferable – when one person in a couple dies, their NRB can transfer to the surviving spouse, making their NRB on their own death £650,000. This is just one of many ways of improving the chances of keeping your wealth in the family.
There is also the Residence Nil Rate Band of £175,000 per person. This applies to the value of your home, only provided you have left your home to direct descendants.
Gifting to mitigate Inheritance Tax
One way to mitigate Inheritance Tax is to spend your wealth, but many of you would never achieve that or would want to. Another way is via gifting. HMRC currently allows you to pass on some of your wealth as gifts, which covers anything which has value – money, property, and possessions being the most commonly gifted assets.
The types of gifts you can make are Exempted Gifts (Exemptions) or Potentially Exempt Transfers (PETs).
The current limits apply to Exemptions from your estate:
- £3,000 of gifts in any one tax year (you can carry any unused exemption forward to the next year, but you can only carry each year over once)
- Wedding or civil ceremony gifts of up to £1,000 per person, rising to £2,500 for a grandchild and £5,000 for a child.
- Normal gifts out of your income – you must be able to prove that you are able to maintain your standard of living after making the gift.
- Payments to help with another person’s living costs, such as an elderly relative or a child under 18.
- Gifts to charities and political parties.
- You can give away as many gifts of up to £250 per person as you like during the tax year, so long as you have not used another exemption on the same person.
It is also important to note that if an asset experiences a loss in value when you transfer it, it also counts as a gift. For example, if you sell your house to your children for under market value, the difference in value counts as a gift.
Potentially Exempt Transfers (PETS)
Potentially Exempt Transfers (PETs) are subject to the Seven Year Rule, which we have written about previously. Briefly, these are gifts which cease to form part of your estate after seven years have elapsed. Visit our previous article to read about these in depth.
Any gift you make must be unconditional, which means you must derive no benefit from it all. If you do benefit from the gift, this falls into a different category altogether, called Gifts With Reservation of Benefit (GWROB). This does the very opposite of mitigating IHT. I recall a client who gave his children Premium Bonds but along with them a letter saying, if they won, they must share the proceeds with him. This is considered to be a GWROB, so would not mitigate the tax.
If you transfer your home to your children during your lifetime and continue to live in it rent-free, this would also count as a GWROB. One way around this which the Revenue allows is if you pay a market rent minus expenditure.
Inheritance Tax is just one (rather big!) piece of the entire intergenerational wealth planning puzzle. As you can see, it is often not straightforward, and it is best to seek advice. So, if you are thinking of mitigating Inheritance Tax in any way, please do not hesitate to get in touch.