Ways to avoid inheritance tax
The basic rules of inheritance tax (IHT) are fairly simple:
- When you die, everything you own forms part of your estate.
- IHT is due on the value of your estate.
- The rate of IHT is 0% on the first £325,000 of your estate (which is known as the nil-rate band), and 40% on the rest.
There are a number of legal ways to save inheritance tax. They involve appropriate planning in your will and certain actions that you can take during your lifetime.
Gifts to spouse or civil partner
A person who is married or in a civil partnership may make a gift to his spouse or civil partner at any time (whether during his lifetime or after his death) without incurring any IHT liability. So if a married woman, for instance, leaves all of her assets to her husband when she dies there will be no IHT charge on the gift.
Combined nil-rate band for married people
Since October 2007, a surviving spouse (or civil partner) has been allowed to apply the unused part of the deceased spouse's nil-rate band (NRB) to their own estate. If the deceased spouse leaves all of his assets to the surviving spouse, then the surviving spouse will be able to use the combined total of their respective NRBs (which would currently be 2 x £325,000, or £650,000 in total).
If the first spouse to die used some of his NRB (for gifts to children, for example), then the percentage of his NRB that he did not use will be available for use when the surviving spouse dies. (Note that this is done in percentage terms, so if the NRB increases after the first spouse dies, the unused percentage will be applied to the nil-rate amount in force when the second spouse dies.)
- Note: the rule allowing married/civil partners to combine their NRBs applies if the surviving spouse dies on or after 9 October 2007. The first spouse can have died at any time (although there are some special rules that apply if they died before 1975 -- consult a solicitor for advice).
Lifetime gifts -- potentially exempt transfers
In general, when a person makes a gift during his lifetime (other than to his spouse or civil partner), the gift will be a potentially exempt transfer (PET). That means that if the person making the gift dies within seven years of the date of the gift, IHT will be due on the gift. The rate of IHT varies, however, depending on how long the donor survives after the date of the gift -- beginning in the third year after the gift it is reduced by 20%, and it continues to be reduced, year by year, until it is eliminated entirely at the end of the seventh year.
Therefore, a lifetime gift can be an effective means of reducing the eventual IHT liability on the donor's estate -- provided the donor lives for at least three years after the date of the gift.
If, however, the donor retains an interest in an asset that he has purportedly given away, the gift will not count as a PET and the asset in question will be included in the donor's estate when he dies.
Other lifetime gifts that can reduce IHT
Annual exemption: You can give away up to £3,000 per year, free from IHT, and you can carry forward any unused part of that £3,000 of the exemption for one year.
Small gifts of up to £250: You can make any number of small gifts of up to £250 (although you cannot combine the £250 small gift exemption with any part of your £3,000 annual exemption for a gift to the same person).
Regular gifts out of income: Certain regular gifts that you make out of your income (but not from your savings or other capital) are exempt from IHT. An example might be the regular payment of a life insurance premium on a policy written for someone else's benefit.
Marriage gifts for relatives: Parents can give a child a gift of up to £5,000, free of IHT, when the child gets married (or enters into a civil partnership). Other relatives can give lesser amounts, and anyone else can make a gift of up to £1,000 free of IHT liability.
The annual exemption, and even the small gifts, can add up to a significant sum over a period of years. So a programme of regular giving can form a significant part of a person's estate planning.
Business assets comprising a going concern or an interest in a business may qualify for business relief from IHT. Depending on the type of business (or the type of interest in it) the relief can be either 50% or 100% of the IHT that would otherwise be due. Most small, family businesses (other than businesses engaged in trading and/or holding investments) that are not quoted on a stock exchange will likely qualify for the 100% relief.
With the correct advice and planning, it is also possible to get the IHT business relief if you give away a business during your lifetime.
If you're thinking about giving away a business during your lifetime, or if you are relying on the availability of business relief for a post-death gift, you should get professional advice as to the availability of business relief for the particular type of business and/or assets involved.
Agricultural land, woodlands, and heritage assets
There are also IHT reliefs available for agricultural land, woodlands and heritage assets (such as a stately home or important work of art). You can find more information about these reliefs on HM Revenue and Customs website.
Getting help with estate planning
Good estate planning advice may save your family and other beneficiaries many thousands of pounds in IHT using legal and readily available exemptions and reliefs. There are many solicitors and other professionals who specialise in estate planning work (and who understand not only IHT, but also the other taxes that come into play in estate planning). You can find a solicitor in your area for free via solicitor matching services, which can also help you to understand the best course of action for your situation and whether you are even ready to hire a solicitor.
This content is subject to Crown Copyright