IT’S ONLY NATURAL TO WANT TO PASS ON WHAT YOU OWN TO YOUR CHILDREN WHEN YOU PASS AWAY BUT INHERITANCE TAX ( IHT ) CAN CAST A SHADOW OVER YOUR PLANS TO PASS ON YOUR ASSETS.
Inheritance Tax planning expert Calvin Healy talks you through the basics and explains how to reduce the amount of IHT you pay, so your loved ones benefit rather than HMRC.
IHT is a controversial subject and one which can be divisive, with ideas about its use as a revenue generator for the Treasury often being split along party political lines.
Currently, HMRC (HM Revenue and Customs) can claim a whopping 40% of the value of any estate exceeding £325,000, including property, cash, and assets. And with average house prices in the UK hitting £287,782 in October last year, the number of people whose assets are above the threshold are increasing year-on-year.
Fortunately, there are ways to navigating the risk of a huge tax bill eating away at your children’s inheritance, but, as with all things tax related, this involves some forward planning.
The IHT threshold
Top tip number one is stay below the inheritance tax threshold!
Inheritance tax is charged on the value of an estate that exceeds £325,000, an estate being all the assets, property and cash someone owns. So, if your estate is valued at £400,000, the £75,000 that lies above the threshold is subject to inheritance tax, charged at 40%.
If you own your own home, there is an additional allowance of £175,000 allowance if you wish to leave this on to your children or grandchildren.
There’s no IHT to pay if you pass your home or other assets on to your spouse or civil partner on your death. Both the £325,000 allowance and the £175,000 allowance can be transferred to the surviving partner, meaning that couples can have a combined threshold of £1 million, if all the right conditions are met.
Of course, the conditions are the tricky bit. There are caveats that mean this is not quite straight forward, for instance, the tax-free threshold on your home only applies if it is being passed on to your children or grandchildren and also, your overall estate must be worth less than 2 million.
If you leave the home to another person in your will, it counts towards the total value of the estate.
So how can you keep your estate within these limits?
Giving gifts
First, gifts can include all sorts of donations, including money, personal goods, property, stocks and shares. Crucially, you must not continue to benefit from the asset you have given away, however.
Giving away your main home for example, could be a great way of reducing the overall value of your estate. HMRC will not, however, consider a home that you gave to a family member but continue living in as a gift. You can remain living in the property, but you will have to pay a standard market rent to the ‘new’ owner. The payment of rent can be seen as a way of gradually redistributing some of your wealth and supporting family members prior to your death.
You are also entitled give away a total of £3,000 worth of gifts each tax year without them being added to the value of your estate. This can either be given to one person or split among several. You can also use any unused allowance forward to the next tax year.
If a friend or family member gets married there is also a wedding gift allowance, which lets you give the following while escaping inheritance tax:
- £5,000 to a child
- £2,500 to a grandchild or great-grandchild
- £1,000 to any other person.
If you’re giving gifts to the same person, you can combine a wedding gift allowance with any other allowance, except for the small gift allowance.
As with everything tax, there’s a but and in this case it’s quite a big one. Any gift above the level of the gift allowances, including your home, will be subject to the seven years rule, which says that a gift is only tax-free if you survive seven years after the date you gave it. It’s a sliding scale, if tax is payable in respect of the gift. See the table below to see how it works.
Years between gift and death | Rate of tax on the gift |
3 to 4 years | 32% |
4 to 5 years | 24% |
4 to 6 years | 16% |
6 to 7 years | 8% |
7 or more | 0% |
Giving gifts out of surplus income, is a very useful and underutilised relief which if used correctly takes the whole gift outside of inheritance tax.
Calvin Healy
Put assets into a trust
Another possibility is to set up a trust. This is an agreement where you put some of your assets under supervision of a trustee for the benefit of a beneficiary. If you do that, the relevant assets will not form part of your estate when you die.
Setting up a trust is a big decision, however, as you may not be able to recover your assets if you change your mind. Despite this many see them as a great vehicle to reduce inheritance tax and hold assets ready for an individual when they come of age, for instance.
Family Investment Company (FIC)
This is a private limited company, with the shares held by various family members, usually from different generations.
Where you have revenue generating assets, such as rental properties, these can be passed into the ownership of the FIC rather than the individual/s. Once this happens the business income will be subject to corporation tax but will avoid IHT.
A shareholders’ agreement should set out how the company is run, by whom, plus who will be paid and how.
This arrangement means that you can continue to use and manage your assets, as well as taking income from them, but they will no longer belong to you. They will instead belong to a company, which is owned by the shareholders you decide upon.
Both the FIC and trust options really require expert professional input to ensure they are properly set up to achieve your goals without unforeseen issues arising. Speak to a tax adviser who has had lots of experience dealing with this area.
Leave something for charity
Anything you leave to charity will not be touched by inheritance tax. Furthermore, if you leave 10% of your assets, your inheritance tax will reduce from 40% to 36%.
Tax is always a complicated subject, there is a lot more to estate planning than what we’ve touched on here. So, if you want to pass on absolutely everything you can when your time comes, make sure to you speak to an expert.