Inheritance Tax Planning: How to Reduce Your Tax Bill

What is Inheritance Tax

Inheritance Tax, usually abbreviated to “IHT” is a tax on transfers of value i.e. inheritance on death or gifts in lifetime payable to HMRC. It is commonly thought of as a Tax arising only on death, which it often does. However it isn’t just paid on the assets owned by the Deceased as at the date of death, it may also be payable on gifts made by the Deceased in the seven years before they died. How much is paid depends on the net value of the estate – all assets less any debts.
However, there are exemptions from IHT for people in certain risky roles including the armed forces personnel, police and firefighters. In addition, if all your assets are left to your spouse or civil partner, provided they are resident in the UK, then your estate will be exempt from IHT regardless of the value. Also, any assets passing to a registered charity are exempt from IHT, again regardless of the value.

Why do you have to pay inheritance tax?

The taxman has been taking death duties in one form or another for centuries. Inheritance Tax was originally a tax on personal property passed on in wills. More recently the government brought in estate duty to clear government debt. Since then, death duties have proven to be a valuable income stream for the government via HMRC.

How much is Inheritance Tax?

The standard Inheritance Tax rate is 40%. It is generally only charged on the part of your estate that’s above the threshold, or 36% if you leave 10% of your estate to charity.

What is the Inheritance Tax Threshold?

In the tax year 2020/21 the inheritance tax nil-rate band, also known as the inheritance tax threshold, for individuals is £325,000. This nil-rate IHT band is transferable to a spouse or civil partner on death resulting in a total nil-rate band of £650,000 for couples, subject to any lifetime gifts.

How much is the NIL Rate Band?

The first £325,000 of your estate is generally free of IHT. This is known as the Nil Rate Band (“NRB”) and the current NRB of £325,000 has been frozen since 2009. There is normally no tax to pay if the value of the estate is less than £325,000 or you leave everything to your spouse, civil partner or a charity.
However, depending on your circumstances this may be higher. In particular if you leave your property to a direct descendant(s) i.e. children (including adopted, foster or step-children) or grandchildren you may have an additional tax free allowance of £175,000. This is known as the Residence Nil Rate Band (“RNRB”).
You may then effectively have two tax-free allowances where IHT may not be due on the first £500,000 of your estate.
However, the RNRB can only be used in respect of one residential property which does not have to be the family home. Restrictions apply where estates are in excess of £2 million.

Inheritance Tax regarding Property

If you pass a property to your husband, wife or civil partner when you die then there is generally no Inheritance Tax to pay. However, if you leave the property to another person in your will it will count towards the overall value of the estate unless you leave it to a direct descendant i.e. children (including adopted, foster or step-children) or grandchildren. If you do then the Residential Nil Rate Band of £175,000 may be available if your estate is worth less than £2 million.

Inheritance Tax Calculator

It is worth knowing what your potential Inheritance Tax bill may be and the example below gives you an idea how the Nil Rate Band and Residential Nil Rate Band can reduce the IHT which may be due.
You have an estate worth £650,000. You decide to leave your home to your children. This means no Inheritance Tax will be charged on the first £500,000 of your estate (£325,000 NRB plus £175,000 RNRB). There will be a 40% charge on the remaining £150,000 being £60,000 – this would be reduced if you leave 10% of your estate to charity being £54,000 due instead of £60,000.
If you were not leaving your property to your children/grandchildren or if you have no children, then you would pay nothing on the first £325,000 and 40%, or 36% if 10% going to charity, on the remaining £325,000.
However, working this out can be complicated and it is always worth discussing this in more detail. Get in touch with us by emailing to discuss how we can assist you with calculating what your potential Inheritance Tax liability may be.

6 Ways to Reduce or Avoid Inheritance Tax

Tip 1: Make a Will

Making a Will and keeping it updated as your circumstances change is the easiest way to try to reduce or avoid Inheritance Tax. If you do not have a Will in place then your estate will be divided up per the Intestacy rules and may be liable to Inheritance Tax. In particular, if you are separated (but not divorced) or living with a partner, then without a valid Will in place, your assets may pass to the wrong person. If you are concerned about who inherits your estate and/or if you wish to reduce your Inheritance Tax bill, then you should ensure you have a Will in place. We generally recommend that you review your Will every three years. Get in touch with us by emailing to discuss how we can assist you with preparing or updating your will.

Tip 2: Stay within the Threshold

The current Inheritance Tax threshold, also known as the Nil Rate Band, is £325,000 for individuals. This is transferable to a spouse or civil partner on death possibly resulting in a maximum total Nil Rate Band of £650,000 for couples. In addition there is an extension to the Nil Rate Band where the Deceased held an interest in a property. This is known as the Residential Nil Rate Band and is currently £175,000 per person. This is also transferrable to a spouse or civil partner or death possibly resulting in an additional £350,000 for couples being an overall total of up to £1 million for couples.

Tip 3: Gifts

Gifts to Spouse/Civil Partner:
Gifts between spouses/civil partners are generally exempt, if both are domiciled in the UK.
Gifts to Charities:
Any gifts to registered charities are generally exempt.
Small Gifts:
You can give up to £250 to as many people as you like in any tax year (6 April to 5 April). There is no limit to the number of recipients, as long as no individual receive more than £250 per year from you.
Annual Exemption:
You can make gifts up to £3,000 per tax year. Any unused balance of this allowance may be carried forward for a maximum of one year, provided that the latter year’s exemption has been used up completely.
Wedding Gifts:
You can give up to £5,000 to each of your children (including adopted and step-children) on the event of their marriage. You can give up to £2,500 to each of your grandchildren or great grandchildren on the event of their marriage. A gift of £1,000 may also be made to any other person on the event of their marriage.
Gifts out of Income:
To qualify for this exemption, the gifts must: be made out of your income; form part of your usual expenditure (you should keep records to be able to demonstrate a habitual pattern); and leave you with sufficient income to maintain your usual standard of living without having to dip into savings to make up your income.

Tip 4: Life Insurance

Life Insurance can be used as a means of removing value from an estate and also as a method of funding any Inheritance Tax liability. By writing a life policy in trust this will avoid the pay-out forming part of the estate thereby not increasing or creating an Inheritance Tax liability.

Tip 5: Trusts

Once property or money is moved into a Trust it ceases, after a period of time, to form part of the Deceased’s estate provided the donor does not obtain any benefit or enjoyment from the Trust. However, depending on the amount settled into the Trust, the settlement may result in an Inheritance Tax liability. The downside of a Trust is that the individual loses control over this cash or property. There are however ways in which this can be addressed for example through the careful choice of Trustees and retaining the exclusive right to appoint new Trustees.

Tip 6: Give your Assets Away

The basic rule is that if a person survives for at least seven years after making a gift to an individual (regardless of the value) then that gift will become exempt and need not be taken into account for Inheritance Tax purposes, provided it is an outright gift, meaning no conditions are attached and the donor does not continue to enjoy and benefit from it.

How Inheritance tax planning solicitors can assist

With proper professional advice, many people find that they can reduce or totally eliminate any potential Inheritance Tax liability following their death and so leave more to the chosen beneficiaries of their estate. This is generally done by regularly reviewing their financial affairs, updating their Will to suit their own needs and wishes and as their circumstances change particularly on marriage, separation or divorce.

Estate planning

Estate planning generally involves making lifetime transfers to make use of the available exemptions and reliefs or to benefit from a lower rate of tax on lifetime transfers. However, careful consideration needs to be given to other factors such as Capital Gains Tax liability which may inadvertently be created when trying to save Inheritance Tax.
Here at Caritas Legal we understand estate planning can be a difficult subject to consider. Whilst these general tips can be useful regarding Inheritance Tax planning, it is always important to tailor the strategy to fit your particular situation.

Contact us today on 01383 431 101 or to make your initial appointment to discuss your options and have the burden eased by our expert, empathetic advice.

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