Inheritance Tax Planning

The inheritance tax paid on an individual’s estate upon their death is charged at a hefty 40% rate on the value of their estate after deducting the tax-free inheritance tax threshold, known as the ‘nil rate band’. The value of an estate is comprised of all of the deceased person’s assets, including property, shares and savings. The inheritance tax nil rate band is currently £325,000 and an additional property allowance of £175,000 on top of this has been brought in for those owning a main property that is being passed to their direct descendants, bringing the overall total to a potential £500,000 per individual or £1 million for married couples and civil partners. Any unused nil rate band can be transferred to a surviving spouse or civil partner.

For those with an estate valued above this level, a number of steps can be taken throughout their lifetime to minimise the amount of inheritance tax that will become payable upon their death. While no one likes to think about death, careful planning will ensure that as much as possible of an individual’s hard-earned estate is left to their intended beneficiaries rather than it going to HMRC’s coffers.

Lifetime Gifts

Gifts made during an individual’s lifetime can be made tax-free during that individual’s lifetime, and as long as the individual survives seven years after making the gift, those gifts will not be liable to inheritance tax. It is therefore worth considering passing on any excess wealth accumulated by an individual during their lifetime, which could potentially remain outside of the individual’s taxable estate upon their death. Gifts can include property, however if the individual continues to live in the property they must pay a commercial or market rate of rent to the beneficiary for it to benefit from the seven year inheritance tax-free rule.  For the beneficiary, the rental income would need to be reported on their tax return and the appropriate income tax paid on that income.

Annual and Small Gifts Exemptions

All individuals are entitled to an annual £3,000 inheritance tax exemption which means that this amount can be given away every year without any inheritance tax implications.  Any unused portion of the annual exemption can be carried forward one year, so a gift of £6,000 could be made in one year free of any inheritance tax consequences.  Additionally, the ‘small gifts exemption’ entitles individuals to give away £250 per year to any number of recipients (though this can’t be combined with the £3,000 annual exemption, i.e., the same recipient can’t receive any part of the £3,000 and an additional £250).  As an example, you could give away £3,000 to a child and £250 to each grandchild on an annual basis.

Wedding Gifts

Wedding gifts can be exempt from inheritance tax and the limits are £5,000 for a parent, £2,500 for a grandparent or great-grandparent and £1,000 for anyone else making a wedding gift.

Donations to Charity

By including charitable donations in an individual’s will that amount to at least 10% of the net value of their estate at death, the inheritance tax payable on the remainder of their estate can be reduced from 40% to 36%.

Gifts from Income

One exemption that is often overlooked, but that can be potentially very significant for inheritance tax planning is the ‘gifts from income’ exemption which means that an individual can pay the regular expenses of someone else, as long as that expenditure is paid for from surplus income of that individual and doesn’t deplete their capital or cause them any hardship.  As an example, a parent could commit to paying the mortgage interest or utility bills of a child on an ongoing basis, as long as that parent earns sufficient income to cover those expenses, as well as those required for their own needs.

And Finally…

Alternatively, an easier way to save inheritance tax is to enjoy and spend money during your lifetime and to leave a smaller estate that is within the inheritance tax threshold. Time to book that dream holiday?