Inheritance Tax For Beginners
Inheritance tax combines the two things that Benjamin Franklin said are inevitable: death and taxes. It's a tax on your estate when you die. The tax collector, not content to relieve you of your money while you are alive, will also have a go once you're dead. But read on ... there's some good news too.
In a nutshell: if you die and the value of your assets (property, cash, shares, bonds, priceless works of art etc.) exceed £325,000 (£450,000 if you have a property) then part of the value of your estate may end up in the government coffers as inheritance tax. The tax will come directly out of the estate and therefore reduce the amount of money left to distribute amongst the beneficiaries of your will (you have written one, haven't you?).
The Nil-Rate Band and the RNRB
The good news is that everyone is allowed to leave £325,000 to whoever they like, tax free. This is the 'nil-rate band' and the Chancellor changes it from time to time but it's currently set at £325,000 and due to stay at that level until the 2020/2021 tax year. Anything else you leave behind is taxed at 40% (or 36% if you leave at least 10% to a charity).
If you're married or in a civil partnership then anything left to a spouse or registered partner is tax-free (so long as they live in the UK). And your spouse or partner's inheritance tax allowance is increased by any amount unused by your estate. This effectively means that a couple can leave £650,000 tax-free.
From April 2017 another 'nil-rate' allowance has been available worth up to £125,000 per person (in the 2018/19 tax year). It can get a bit complicated but it's basically another IHT free allowance available if you leave your home to direct descendants. The value of the residence nil-rate band (RNRB) is either the value of your property or the total RNRB allowance - whichever is lower. The £325,000 nil-rate band is applied to the balance of your estate once the RNRB allowance has been applied.
Now, that all sounds very complicated but consider this: if you're single, don't own your home and your assets are worth no more than £325,000 or you're married/in a civil partnership and your combined assets are worth no more than £650,000 then inheritance tax won't affect you at all and you don't need to give it a second thought. The problem is that, these days, even with additional RBRB allowance many people who own their home are likely to leave their family with IHT liability when they die.
Gifts exempt from IHT
So, what should you do? Well, if you don't mind about a potentially significant portion of your estate going to the government when you die then you could do nothing. But if you want to be 'tax-efficient' then there's a lot to be said for giving your money away while you're alive. Any money given away 7 years or more before you die is tax-free. Money given as gifts within 7 years of death gets counted as part of your estate (and therefore potentially subject to inheritance tax, albeit on a sliding scale depending on when it was given away) but there are tax pre-emptions you can use to avoid this which include:
- The first £3,000 given away each year is exempt under the Annual Inheritance Tax Exemption. And you can carry forward this exemption for 1 year.
- Gifts of £250 per recipient, per year are exempt from inheritance tax. So, you could give everyone in your family cash for birthdays and Christmas and enjoy the joy of giving at the same time as reducing your inheritance tax liability. You can only use this exemption if you haven't used another exemption for the same person.
- Gifts to political parties and charities are exempt from inheritance tax. If you don't want to name your favourite charity as a beneficiary in your will you could give them a cash gift while you're alive.
- Wedding or civil partnership gifts of up to £1,000 (parents can give up to £5,000; grandparents and great-grandparents up to £2,500).
- Gifts given from income (pension, investments, salary etc) are tax free.
- Payments to help with the living costs of a dependent are tax free.
Record keeping and IHT
If you intend to make gifts out of your estate to help ease a future IHT burden then it is a good idea to keep decent records of what you give away and to whom. It will help you keep track of your exemption limits and will also make things easier for the executors of your will. Make sure you're clear about the tax exemption limits and any conditions on them.
Getting Advice on IHT Liability
That's the easy stuff, and very much a quick overview designed to get you thinking about IHT. If you're concerned about your inheritance tax liability then make sure that your will is up-to-date and get some professional advice. If you have a large or complicated estate and/or are thinking about setting up trust funds then you should talk to a tax accountant. Inheritance tax allowances are complicated and subject to frequent change so professional advice costing a few hundred pounds could save you much more in the long run.
If you want more information about inheritance tax then you could start at the HM Revenue & Customs website. If you want to write a simple will then you might be interested in the range of will template documents we offer.