How to Avoid Inheritance Tax
What You Need to Know
- As house prices have gone up over the years and the threshold for Inheritance Tax (IHT) has increased very little, more people than ever are liable to pay it.
- The IHT threshold is £325,000. If an estate is worth more than that, the excess amount is taxed at 40%.
- By splitting up your estate in your will, you can insure your loved ones inherit an amount under the threshold.
- Spouses and civil partners are exempt from paying IHT on estates left to them by their partners. If they then die the estate will be subject to IHT but at a higher threshold of £650,000.
- You can give assets away as gifts tax free of a value of up to £3,000 each year. Unused allowance from one year can be carried into the next, but no further.
- If you are thinking of using a trust to avoid IHT, consult a specialist first. The HMRC have been cracking down on trusts used in this way in recent years.
- Taxcafe brings you a variety of useful resources to help you pay less capital gains tax, inheritance tax & other taxes.
Inheritance Tax (IHT) was originally intended to target the super-rich. But since the death levy was introduced in the early 20th century, its thresholds have fallen in real terms, and increasing numbers of homeowners in the UK are liable.
As house prices have gone up over recent years, the threshold at which the IHT bites – known as the nil-rate band – has grown only slightly, meaning that more people than ever now face the tax.
In 2009/10, any estate worth over £325,000 is liable for the flat-rate IHT of 40 per cent on the amount exceeding the threshold. So if your estate is worth £360,000, the IHT bill will be £19,200.
However, it is one of the most avoidable taxes. It has simple loopholes that can be exploited to reduce the amount you have to pay tax on, or even save you from paying IHT altogether.
Where there’s a will…
The key to avoiding IHT is in your will. To ensure that it is legally watertight, always seek professional help when writing or updating a will. This way you will be sure to have all the necessary weaponry to combat IHT.
By leaving your estate to your nearest and dearest in the right amounts, you will protect them from having to pay the tax after you die. Wills.org.uk is a site where you can make your fully legal Will online.
You’re allowed to leave your worldly goods to your spouse or civil partner – no matter what they’re worth – without them having to pay IHT. Spouses and civil partners do not have to pay taxes on possessions handed over to them by their partners. But once the second partner dies anything left of the estate will be subject to IHT – though with a higher threshold of £650,000 for 2009/10.
Use the nil-rate band
The trick here is to make use of the nil-rate band while you’re still alive. First, if you have a spouse or civil partner, you need to divide your assets as evenly as possible between the two of you. Then you should each make wills leaving up to £325,000 to your children – though, as the nil-rate band changes on an annual basis, you might want to simply state that you want to leave an amount “equal to the nil-rate band operating in the year of your death”.
The remainder of your estate should be left to each other.
This way, when one partner dies, your children’s inheritance will be within the threshold and your spouse won’t have to pay the tax either. And when the second parent dies, your children can once again inherit without penalty.
One of the simplest ways to protect your assets from IHT is to give them away in the form of gifts, or Potentially Exempt Transfers (PETs). PETs are gifts made during a lifetime, exceeding the annual gift exemption of £3,000, but within the nil-rate band.
Whatever you hand over free of charge is exempt from IHT as long as you survive the donation for more than seven years. If you don’t, then the recipient will be taxed – but on a sliding scale. Should you pass away within three years of making a PET, your gift will be subject to the full 40 per cent levy. But the tax reduces as the years increase to the maximum seven.
However, making a PET could be pointless if you are in ill health and may not live for seven more years. Likewise, if you’re young you will need to hold on to your assets to support yourself during retirement a PET might not be the right choice. Therefore, you need to give careful thought to if, and when, you make gifts of this sort.
Each year you can also give away £3,000 worth of assets that will be exempt from IHT. These gifts can be combined with a wedding present of up to £5,000 to your children – so you could give your child a total of £8,000 in one year. Grandparents can hand over £2,500, and anyone else can give £1,000 as a wedding gift. Unused allowance from this £3,000 can be taken forward one year, but not further.
You can also make small gifts of up to £250 to an unlimited number of individuals each year – though a small gift cannot be combined with the annual exemption, giving some people £3,250.
Gifts to your husband, wife or civil partner are also tax-free, as long as you both live on the UK, even if you’re separated but still married.
Cracking down on trusts
In the past, many people used trusts to avoid paying IHT. However, Her Majesty's Revenue and Customs (HMRC) has been cracking down on trusts to prevent them being used in this way. Payments into trusts for someone who is disabled, and certain trusts for children, are potentially exempt transfers.
The rules are complex though, and you should talk to a specialist before setting up a trust.
- Thinking of building a legacy? Read our guide to saving for your grandchildren.
- Find out more about the rules around IHT from the HMRC.
- Having a will is one of the most important ways you can help loved ones avoid unnecessary tax. Read out guide to writing a will to find out more.