When you die, the government assesses how much your estate is worth; this includes the cash you have in the bank or in investments, and any property or business you own. If this exceeds the Inheritance Tax threshold set by the Chancellor, you (or technically your estate) will pay tax on 40% of the extra when you die. At present the nil-rate threshold is £325,000. So for example, if you leave behind assets worth £500,000, your estate pays nothing on the first £325k, and 40% on the remaining £175k – a total of £70,000 in tax
It’s important to realise that, when you die, any assets left to your spouse or registered civil partner, provided they’re UK-domiciled, are exempt from Inheritance Tax. On top of this, your partner’s Inheritance Tax allowance is increased by the amount you didn’t leave to others, meaning together a couple can currently leave £650,000 tax-free
Previously, this nil-rate threshold changed every year. However, in the 2010 budget, it was announced that the rate will be frozen for four years, effectively decreasing it in real terms when inflation is factored in
How can I reduce my Inheritance Tax bill?
The first thing to do is to plan as this can save you thousands. yet many people ignore it; either not wanting to consider the future or simply unable to broach it with relatives for fear of embarrassment or seeming morbid or grasping. You really need to get over that. So, whether you stand to inherit or leave the money, it’s time to sit down and tackle these issues with your family as a grown up. Don’t try and couch it in soft terms, the easiest way is to be matter-of-fact and go for it head on
The second, and probably most vital, thing to do is to make a will. One in three people die without making a will, which is basically a statement of how they would like their estate divided up. If this happens, which is known as dying intestate, their estate is divided up according to strict rules of intestacy which basically only allow spouses, civil partners and certain close relatives to inherit. For more on how to make a will, click here
Fourth, you give money away! If the assets aren’t in your estate, you can’t be taxed on them! But, and it’s a very big but, money given away before you die is still usually counted as part of your estate, hence subject to Inheritance Tax, if you die within seven years of giving the gift. Therefore the golden rule is to survive seven or more years – which means early planning of how to pass on your assets is important. Another caveat, and this applies particularly to houses, is that if you give your house away, say to your children, and continue to live in it rent free, it will be known as a ‘gift with reservation of benefit’ and will still be subject to tax
If you make large lifetime gifts, the beneficiaries could take out life insurance against the potential Inheritance Tax bill. Most gifts into trust are now subject to Inheritance Tax even if made during your lifetime, but this is an area where you would need specialist advice
Even if you do die within seven years of making a gift, there are a range of other exemptions worth taking into account to help lessen the tax bill:
1 Annual Inheritance Tax Exemption - The first £3,000 given away each tax year is completely ignored as part of your estate and thus not subject to Inheritance Tax if you die. If you don’t use this in a year, you can carry it forward for one tax year (no more) and use it then.
2 Gifts to charities and political parties are Inheritance Tax free. – Hence leaving money to that cats’ home is at least efficient tax planning
3 Give £250 each year to everyone you know - Gifts of no more than £250 to any one recipient per tax year are excluded from Inheritance Tax. For example someone with 12 grandchildren could give each of them £250 annually as a birthday present and it wouldn’t be counted as part of the estate. This soon helps chip away at the bill
4 Gifts from income - Inheritance Tax is a tax on your assets. However if you have an income (pension or earnings for example) and you give money regularly from that which leaves you enough income not to impact your lifestyle, then it is exempt.
5 Gifts on consideration of marriage - This is a good one! If you give a gift that is conditional on an agreement of marriage or civil partnership i.e. “marry my daughter and I will give you X thousand pounds” it is exempt. There are limits to this though: £5,000 for a gift from a parent, £2,500 from a grandparent, £1,000 from anyone else. However, remember this is not a simple wedding gift, that wouldn’t count. It must be conditional
6 Woodland, Heritage, Farm and Business – This is one of thsoe arcane exceptions. If you own an agricultural property that’s part of a working farm then a percentage may be exempt from tax. Similarly if you own woodland, those who receive it in your will can apply for the timber on it, but not the land itself, to be deemed exempt. Check what happens when the timber is sold though as Inheritance Tax may apply at that time.
Never forget, though, that while Inheritance Tax planning is important, the main thing is that you should have financial security in old age; don’t sacrifice everything just to plan for someone else’s future. You’ve earned your money, so enjoy it!