Inheritance tax payments reach record high - protect yourself
The amount of the money the UK government has received from inheritance tax (IHT) has reached £4.7 billion for the year ending 31 October.
This is up 11.9% from a total of £4.2 billion in the year ending 31 October 2015.
According to Wilsons, a law firm that specialises in private client law (among others), more and more people’s estates are leaving the tax free threshold behind due to the inflation in house prices, along with a freeze on the threshold level itself. Essentially, owners of modest homes have found themselves being grouped with the rich.
The basics of IHT
IHT replaced the ‘capital transfer tax’ in 1986. This replaced ‘estate duty’, in 1974, and so on and so on, deep into history – 1694, in fact, as far as anybody can tell.
The basic set up is that anybody leaving an estate behind is taxed 40% on anything above £325,000.
The threshold rose steadily each year until April 2009, but it hasn’t since. As inflation and house prices have risen since then, IHT has acted as a tax rise.
However, from April 2017 there will be a new threshold for what is being called a ‘family home allowance’. Married couples (and civil partners) will eventually be able to pass on assets worth up to £1 million tax-free as long as they are a homeowner.
This will be tapered in as follows:
- 2017/18 – an extra £100,000 per person
- 2018/19 - £125,000
- 2019/20 - £150,000
- 2020/21 - £175,000
For more on the new £1 million limit read: Your guide to the new inheritance tax rules.
Another addition to the system will be the ‘inheritance tax credit’, which will be used to encourage people to downsize in their old age.
Despite the amount of press IHT gets, the majority of estates still don’t touch the threshold (just over 7% did in 2015/16), and when the new rules activate, the thinking is that the number will shrink.
Cutting your IHT bill now
Meanwhile, there are ways to minimise your exposure as the government has designed a lot of flexibility into the system. Courtesy of Wilsons, here are some of them:
The annual allowance: Each person can give gifts totalling £3,000 per year, tax-free.
The small gift allowance: You can also give away £250 to as many people as you like without incurring any IHT tax. The only stipulation is that the recipient can’t be somebody you’ve used another exemption on.
Surplus income: If you can prove that you have more money than you need to live on, this surplus can be given away IHT tax free. This is very vague, but generally the idea is that once the gift is gone, the donor must be able to maintain their standard of living. It’s also advisable to ensure that these gifts correspond to a ‘settled pattern’ – i.e. this has been part of, or it is intended to be, a regular occurrence.
Giving away property: Look into contributing to a deposit or co-owning a house. It’s worth reading our Ask the Experts article Will we have to pay any tax if we gift a property to our Grandchildren?
Varied deeds: Essentially, this allows one to change a person’s will after their death – as long as the beneficiaries of the original will agree. An example of how this could work is if the beneficiary grows up, has a child, and wishes to pass on their inheritance directly to their child, thus keeping themselves below the threshold.
Clever pensions: Finally, think about your pension. If a pensioner dies once they’re over the 75 years line, the pension will pass on free of IHT – however, income tax will still be a factor. So, if this pension is designated to pass on to somebody who pays less tax (or none at all), everybody wins.
Jessica Broxup, a solicitor at Wilsons, adds: “As a general rule it’s a good idea to review your will every five years to ensure its still fit for purpose.”
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.