Inheritance tax (IHT) has in the past been mainly a problem for the very wealthy – who were generally well-placed to find ways of mitigating it. However, strong growth in property prices in recent years has resulted in many more individuals being caught in the IHT net
Given that most of us are keen for our families to benefit from our estates after our death, what can be done to minimise the potential inheritance tax liability?
First, let’s be clear: minimising liability to IHT, these days, focuses largely on reducing the value of your estate before you die. That in itself can be a troubling prospect for many older people, who understandably feel they might need access to all their wealth if it comes, for instance, to paying for long-term care. It’s important, therefore, to take advice, and to be sure that you understand the possible implications of any tax-planning strategy.
The simplest option, open to anyone with some money they can afford to pass on during their lifetime, is to make outright gifts using the IHT exemptions available. These fall out of the estate as soon as they are given (unlike other types of gift), as we’ll see.
The term ‘outright’ is critical: it’s important not to retain any use or benefit from your gift, or it will be treated as a “gift with reservation of benefit”, which still counts as part of your estate for inheritance tax purposes. So, if you give your house away to your children, you cannot then continue to occupy it (unless you pay a market rent).
As for exempt gifts, everyone has an annual exemption of £3,000, which means you can give £3000 a year to anyone you wish, without IHT implications. You can also carry your annual exemption (or any unused part of it) forward one year if you don’t use it in a particular year, although you cannot carry it forward again to subsequent years.
Additionally, everyone may give away any number of small gifts of up to £250 in the same tax year, as long as each gift is to a different person. But you’re not allowed to give the same individual a large gift (up to £3,000) and a small gift in the same tax year.
Wedding (or civil partnership) gifts are also allowed: each parent can give up to £5,000 when a child marries, and the happy couple can also give each other up to £2,500 before they tie the knot. Grandparents can give up to £2,500, and anyone else has a £1,000 limit.
Marries couples are in a strong position because they have two sets of exemption to use up each year.
Another often overlooked exemption is the capacity to make gifts from everyday income. In other words, provided you can demonstrate that your gifts – of whatever size – are not undermining your standard of living or eating into your capital and that they are regular (even if they are not necessarily worth the same amount), they should fall straight out of your estate. Such an arrangement could work well, for example, when a grandparent is prepared to help with school fees from spare income.
But be sure to keep full records if you’re going to take this path. You should keep detailed annual accounts of salary, investment and other income, together with details of all gifts made, bills paid and other expenditure. It’s important to establish a regular pattern of giving – a letter of intent to the donee can provide helpful evidence. In fact, it’s important to keep records of any gift you make, including a note of which exemption you are using. Such records may only be examined after your death, but they make the executor’s job a lot easier.
Any money that you give away during your lifetime that doesn’t qualify as an exempt gift will be treated as a potentially-exempt transfer (PET). There are no value limits involved, you simply have to survive seven years after making the gift. Only then does it disappear from your estate for IHT purposes. There’s still quite a beneficial tax regime for gifts made to the recipient outright, although the Finance Act 2006 clamped down on those made in trust.
So, for example, you can make gifts up to the value of the nil-rate band (currently £325,000) without liability to tax. If you survive seven years after making the gifts, they automatically fall out of your estate altogether, and you can then begin again by making more gifts to use up your ‘empty’ nil-rate band. If both parents were to follow that strategy for their children, they could pass on £650,000 between them every seven years, at the current nil-rate band level.
If, however, you die within seven years, the gifts must be reported by the executors of your estate, and they will count as the first assets against your nil-rate band, so that it will be at least partially used up before the rest of the estate is assessed. But as those assets would be part of the estate anyway, it may be a strategy worth following, particularly if you’re fit and well.
PETs over the value of nil-rate band will be chargeable to inheritance tax if you die within seven years, but there is a sliding scale – known as a taper relief – which reduces the rate of tax payable if you survive between three and se