All you need to know about Inheritance Tax
Plan for the Freeze in Inheritance Tax Thresholds
The Inheritance Tax (IHT) nil rate band is currently frozen at £325,000 until 5 April 2021. As part of a person’s ongoing Inheritance Tax planning, full use should be made of available exemptions.
The exemptions are relatively small, but, over time the effect can be substantial:
- Annual Exemption – An amount of up to £3,000 can be given away each tax year and, if unused in a year, that amount can be carried forward for one year and utilised in that later year.
- Small Gifts Exemption – You can give up to £250 to as many people as you wish each tax year.
- Gifts out of Income – If your income regularly exceeds your expenditure, you can give away the excess. To gain this relief, the gifts must be part of a settled pattern of giving or there must be evidence of the intention to make these gifts. It may be necessary to ensure that you have evidence demonstrating that the gifts have been made out of your post tax income.
- Lifetime Giving – A person may also consider making lifetime gifts in excess of the above exemptions. A person must survive such a gift by seven years for it to fall out of their estate entirely, and the donor must not benefit from the assets once they are gifted. The gifts might be absolute gifts to family members, or they could be gifts into trust. Gifts into trust can give rise to an immediate charge to inheritance tax at the rate of 20% and therefore, transfers to trust should be limited to the available nil rate band. Trusts can be very beneficial, but specialist advice is needed. You always need to watch if Capital Gains Tax (CGT) arises on lifetime gifts, so you should take specialist advice on gifts of assets rather than cash.
- IHT Efficient Investments – Another alternative can be to place funds into IHT efficient investments, for example, shares in qualifying AIM listed companies. Such investments benefit from business property relief and as such, are relieved from IHT after they have been owned for two years. Appropriate investment advice would be needed when considering such planning, as the commercial risk needs to be considered as well as the tax benefits.
From 2017/18, the Residence Nil Rate Band (RNRB) was introduced as an additional nil rate band of £100,000 where a residence is passed onto a direct descendent. This additional allowance will increase each year by £25,000 reaching a maximum of £175,000 by 2020/21. Care needs to be taken with estates worth over £2m, even where Business Property Relief (BPR) or other reliefs apply.
There are possibilities to ensure estates are reduced during one’s lifetime to prevent a large IHT liability on death. As part of the planning, your advisor would need to consider all sources of wealth and take into account many other factors. The building up of a personal balance sheet and establishing income receipts and living cost requirements can bring planning possibilities into focus. Early action can often lead to a large part of one’s estate being shielded from IHT.
If a higher rate or additional rate taxpayer makes a Gift Aid donation, further tax relief is available to the donor over and above the tax relief claimed by the charity.
A Gift Aid donation of £80 is worth £100 to the charity. A higher rate taxpayer will qualify for further tax relief of £20, so the net cost of the donation is only £60. For an additional rate taxpayer, the further tax relief is worth £25, so the net cost of the donation is only £55. You should keep a record of Gift Aid donations made in the year. Finally, please remember that if you are not a UK taxpayer, you cannot make Gift Aid donations. As an alternative to or in combination with gift aid donations, if you are in a position to leave at least 10% of your estate on death to charity, the rate of inheritance tax charged on the balance of your estate is reduced from 40% to 36%. Whilst this appears quite modest, the savings can be significant: if one takes £1m on which inheritance tax is due at 40%, the inheritance net of tax is £600,000. If £100,000 was given to charity, only £900K is left, but after tax at 36%, £576,000 is left. Thus, £100,000 is passed to charity at a cost of £24,000 to the family.