In years gone by the question of Inheritance Tax (IHT) was one which only really had to be considered by the very wealthy. The current state of the property market in the UK, means that more and more people are being pulled into a situation in which the value of the family home when they die means that their estate in general (the sum of everything a deceased person leaves to beneficiaries) is worth enough to pass the threshold for IHT.
Put simply, IHT is payable at the rate of 40% on the value of an estate that is over £325,000, and isn’t charged on any estate worth less than £325,000. The fact that this threshold was frozen until 2028 by Chancellor Jeremy Hunt in the Autumn 2022 statement means that more and more people are likely to find themselves in the position of having to think about IHT, and how to minimise their liability, in the years to come.
Inheritance Tax
In practical terms, the amount of an estate that can be exempt from IHT is more than £325,000 in the case of someone leaving everything to a spouse or civil partner, in which case the £325,000 is passed on, raising the amount to £650,000. In addition to this, the Residence Nil-Rate Band (RNRB) is a form of relief that applies to the main residence of the deceased if it is passed on to a direct descendant. The relief is worth £175,000, which means that the amount which can be left by an individual without incurring IHT becomes £500,000, and when the allowances are passed, upon death, from one spouse or civil partner to another, this means that the full amount can hit the £1million mark.
According to figures released by the government in July 2022, 3.76% of all UK deaths during the tax year 2019 to 2020 resulted in an IHT charge, and the amount of money brought into HMRC by IHT during the financial year 2021 to 2022 was £6.1 billion, an increase of 14% on the previous financial year.
What these figures demonstrate is that although IHT still impacts a relatively small percentage of the population, the impact when it does occur is pretty big – the figures equate to 23,000 deaths generating an IHT bill of £6.1 billion, an average of roughly £265,217 per person. With property prices in England and Wales still increasing at a rate of 5.5% according to the figures for February 2023, more and more people could find their own estates being included in the tax take for future years – particularly if they are based in a property hotspot – if they don’t take positive steps to avoid this happening.
Writing a Will
The most important step to take before anything else is to make sure that you have a Will written. This may sound like obvious advice to anyone thinking about estate planning, but the fact of the matter is that, according to a report published by the National Will Register, only 44% of UK adults have actually made a Will.
In terms of IHT this omission could have a devastating impact. On a personal level this means that the deceased can’t be sure their estate is being shared amongst their family as they would have wished, but on a practical level dying without a Will means the estate has to be divided in accordance with the laws of intestacy. This would see the entirety of any estate passing on to the spouse or civil partner of the deceased. Only the first £270,000 in assets and half of the rest of the estate will be passed on in this manner, with any children receiving a share of any value of the estate worth more than £270,000.
Since children are not exempt from IHT in the way that a spouse or civil partner is, this could result in them having to pay an IHT bill and therefore losing a significant chunk of the value of the estate. If the will dictates that everything should pass to a spouse or civil partner, on the other hand, exemptions such as the personal allowance will still apply, and the surviving spouse will be in a position to take further steps to make the kind of arrangements which can be used to minimise IHT due when the estate is finally passed on to any children.
Gifting
Gifting is one of the arrangements that can be used to ‘shrink’ the size of the estate and thus reduce any liability for IHT. Up to £3,000 per year can be gifted tax free, and will not then be counted toward the value of the estate when any IHT is calculated.
The £3,000 cap can be carried forward for one year if it isn’t used in full, whilst additional gifts can be given in celebration of a wedding, or a civil ceremony – £5,000 to your child, or £2,500 to a grandchild.
If you opt to give gifts larger than these amounts then there will be no IHT to pay on the amount in question provided you live for another 7 years after making the gift. If you die sooner than this, and the gifts fall outside the limits set out above, then IHT will be due, in a percentage which tapers depending upon the timescale. If the gift was given within 3 years of your death then it will be taxed at the standard rate of 40%, but this slides gradually to just 6% if the gift was given between 6 and 7 years prior to your death.
Another method to reduce the potential IHT bill on an estate is to downsize. This presumes that the children have moved away from the family home, which can then be sold and a percentage of the proceeds used to purchase a smaller home. The money then left over from this sale could be gifted to the children on the basis set out above, and provided you go on to live for more than 7 years after making the gift.
Traditionally, a pension has been there to ensure that you have enough to live on once you stop working. If you’re in a position to fill a pension pot and then not tap into it, or at least to leave a substantial sum still in the pot, then it could do a great deal to cut any IHT bill.
This could be done if you’re in a position to sell off assets that would be liable to IHT, such as second homes, shares and business assets, and live off the proceeds whilst leaving the pension pot intact. This would be helpful because a pension pot can be passed on free from IHT, although the sale of assets would be likely to generate Capital Gains Tax, so the advice of a tax expert should be sought when choosing which assets to dispose of.
The ‘pension pot’ method of minimising IHT liability became even more attractive following the 2023 budget, in which the chancellor scrapped the lifetime allowance for pensions, removing any limit on the amount which can be placed in a pension pot without having to pay tax on it.
Should you require advice on how best to manage your wealth to reduce the impact of IHT, please contact us for an impartial, confidential consultation.
