Inheritance Tax Planning

What is inheritance tax?

It’s one of the biggest things on people’s minds at certain times, so I’m going to be really specific and pedantic about it.

In this country, inheritance tax (IHT) is not a tax on the amount people receive as an inheritance. It’s a tax on the value of one’s assets when you die. It’s actually a tax on your estate.

In the UK, inheritance tax is levied once someone has passed away, based on property, money or any other possessions anywhere in the world

If the value of the estate is below £325,000, no inheritance tax is payable. This limit is known as the Nil Rate Band threshold. If there is no additional allowance available and the estate exceeds this threshold, then standard IHT would apply at 40% on everything above £325,000.

There is an additional allowance that George Osborne introduced of an additional £175,000 if you pass your home to direct descendants – your children or grandchildren. In this case, the threshold can increase to £500,000 per parent.

There is also an exemption that applies to a spouse, a civil partner or a charity, where there is no inheritance tax to pay if everything is left to you by your spouse.

It’s important to remember that gifts made during your lifetime could be subject to inheritance tax if you pass away within seven years of making the gift.

What are the individual and joint inheritance tax allowances?

For an individual, we mentioned the £325,000 Nil Rate Band. There’s an additional £175,000 if you leave property to direct descendants, so that’s £500,000 for one individual.

If you’re married or in a civil partnership and you leave everything to your civil partner or spouse, there is no inheritance tax to pay on first death. It’s all paid on second death.

So the joint estate will have the £325,000 Nil Rate band, plus £175,000 for the residence nil rate band (the additional allowance), plus you can transfer £325,000 of your spouse’s unused Nil Rate Band and another £175,000 unused Residence Nil Rate Band. So in total, a couple can leave £1 million tax free to direct descendants.

How do you avoid inheritance tax?

This is not tax evasion – this is a perfectly legal thing to do. As a previous chancellor said, ‘inheritance taxes are a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.’

It’s perfectly possible, but it’s more difficult these days because many people live in houses worth more than the inheritance tax thresholds. In the south east, around the M25 and London, a typical family property can be worth over £1 million.

But lots of things can be done – you really shouldn’t need to leave your beneficiaries having to pay a lot of inheritance tax if you plan early for it.

One way is using Trusts – placing assets in a Trust can help reduce the value of your estate, but the rules can be complex and you need advice. Of course, we provide advice on Wills that contain Trusts which often help.

Charitable donations won’t end up with your children or your bloodline, but leaving money to charity in your will would reduce or eliminate inheritance tax on that portion of your estate.

People who worry that their children won’t have enough money to pay the inheritance tax bill can consider taking out a life insurance policy to cover it. That might be relevant if you own properties that cannot easily be sold when you’ve died, and you want your heirs to have the money to deal with the properties and pay HMRC.

The simplest and most effective thing to do is spend the money – why not? That’s really the whole idea of savings, especially if you haven’t got children. Or, you can give away wealth as long as you survive for seven years. So enjoy your wealth, or gift it early, and you can reduce the size of your taxable estate.

How can people avoid inheritance tax on a property?

People typically ask whether it’s tax effective to give away the property you live in. I’ll talk about that a bit more in the following questions.

How do the rich avoid paying inheritance tax?

It can be through complex Trusts, set up overseas. This really requires very specialist, very expensive advice from solicitors. I’m talking about advice that costs tens of thousands of pounds. Of course, governments are trying to clamp down on that sort of avoidance.

Avoiding inheritance tax with a Trust, as I mentioned, can be done with simple Will planning – but it doesn’t always work within your generation. It would be saving inheritance tax for future generations. It’s about the inheritance you leave passing down to your children, grandchildren and great-grandchildren without them paying inheritance tax on their estates.

The other topical area is farmland. I have not come across an estate containing farmland so I can’t comment in detail, but with good planning you can leave the farmland to the children or grandchildren while you retain the property you live in. The normal allowances should be sufficient.

Can I buy my parents’ house to avoid inheritance tax? Can I give my house away to avoid inheritance tax?

Don’t do it. It usually ends in disaster. First of all, HMRC would deem this to be a gift with reservation of benefit or a GROB – not a very nice word.

It’s not effective in saving inheritance tax if you carry on living in the property. You might read that it would be effective if you pay your children a going rent – so you give the property to your children and then pay rent for living in the home.

That has other dangers. First of all, the children would have to pay income tax on the rent you’re giving them, so that’s not very tax efficient. And, if your children get divorced, you could find the home you’ve given them is part of their assets – and you could be kicked out.

You’ve given them the property to try and save inheritance tax, but in the end you lose it entirely. So that’s not a helpful suggestion, even if you do read it in the newspapers.