We all want to ensure our loved ones are looked after when we die. That said, we are all aware of the hugely unpopular inheritance tax.
In June 2019, the Office of Tax Simplification (OTS) agreed that the 'complex and confusing' inheritance tax system needed a complete overhaul as parts of the tax legislation are 'poorly understood, counter-intuitive’ or simply ‘unclear'. Some of the rules could mean leaving bereaved families with unexpected hefty bills.
Currently, inheritance tax brings in £5.7 billion per year. This is set to rise to £6.9 billion by the tax year 2023/2024. In 2015, the then Chancellor of the Exchequer, George Osborne, pledged to increase the tax-free threshold for married couples to up to £1 million by 2020. Sadly though, not everyone can or will benefit from these new rules, which came into effect in 2017. Most other exemptions have remained frozen for decades.
Inheritance tax, introduced in 1986, is charged at 40 per cent on estates worth more than £325,000 — known as the nil-rate band.
In most cases, married couples and civil partners can inherit their spouse's entire estate tax-free, and pass on any of their unused allowance to their surviving partner which effectively doubles the tax-free limit for couples to £650,000. This has not risen in line with inflation. Had this happened, you would now be able to pass on £423,000 tax-free (£846,000 for couples).
On top of the regular allowance, since April 2017, there is also a new residence nil-rate band for individuals leaving their main home to a direct descendent — to children and grandchildren. Stepchildren and adopted children are also considered to be direct descendants within this allowance.
This currently stands at £150,000 (£300,000 for couples) and is set to rise to £175,000 (£350,000) from April 2020. Then, parents will be able to pass on an estate on death, which includes their main home, worth up to £1 million, to their children tax-free.
What exemptions are available for lifetime gifts?
The small gifts allowance allows you to make gifts of cash or belongings of up to £250 each tax year free from inheritance tax. You can do this as many times as you like, so long as they go to different people.
But several payments to the same person over the course of the tax year that add up to more than £250 may not be free from inheritance tax.
The annual gift exemption allows you to give away money or belongings to a total value of £3,000 every year. Even if you die immediately after making the gift, your loved ones still won't face a tax bill for such gifts. There are no restrictions on who you make the gift to, and you can roll your allowance over for one year.
There are calls for this annual gift exemption to be increased. Had it risen in line with inflation it would now be worth £11,900.
The OTS has recommended merging this allowance with the marriage exemption to create an overall personal gifts allowance. The marriage exemption currently allows parents to each give up to £5,000 to children ahead of their wedding or civil partnership, free of inheritance-tax — a total of £10,000 from each parent.
Grandparents and Great-Grandparents can give the couple up to £2,500 (£5,000 together) and other relatives or friends, £1,000.
Inheritance tax replaced capital transfer tax in 1986 to encourage people to pass on wealth in their lifetime. This is because you do not have to pay inheritance tax at the time of making an absolute gift, regardless of its size. However, since 2006, gifts into most types of trusts are immediately chargeable. It is exempt from tax altogether if you live for more than seven years after the gift is made.
Making lifetime gifts also reduces the size of your estate and any potential inheritance tax liability on death.
The legislation states that it is the person who received the gift who is liable for any tax bill — even if they have already spent it. If the individual does not pay within 12 months of the death, the estate is jointly liable for the bill. The tax-free allowance is allocated in chronological order, after the end of the month, meaning one child could come under the nil-band allowance whilst the other gets fully taxed. It is worth noting that if you are concerned loved ones could be chased by HMRC, you can leave a provision in your will that states inheritance tax due should be paid by the estate (assuming there is sufficient to do so ) rather than individuals who received gifts.
After three years, the amount of tax owed on gifts that exceed the tax-free allowance, gradually reduces from 40 per cent to 8 per cent.
This little-known exemption allows you to give away any sum of money free of inheritance tax. The money must come from a source of surplus income, for example salary, pension, dividends etc. The gift must also be a regular payment, rather than a one-off sum, e.g. paying for your grandchild's schooling, and the payments must not reduce your standard of living. Gifts to charity and main political parties are exempt. These are exempt both for lifetime gifts and on death.
Usually, your pension pot doesn’t count towards your estate when you die, so it can be passed on without inheritance tax taking a chunk. If you have not touched your defined contribution pension and die before you are 75, then your family can claim the entire pot tax-free within two years. If you die after you turn 75, your nominated beneficiary will have to pay income tax at their usual rate on it.
If you have already started drawing down on your pension, and die before 75, your nominated beneficiaries can get a lump sum or drawdown payments without paying tax. If you die aged 75 or over, they will again pay income tax.
If you have a defined benefit pension (final salary pension) and die before 75, your beneficiary will usually receive a fixed lump sum tax-free. Yet if you're 75 or older when you die, your beneficiary could face an income tax charge.
If you give away at least 10 per cent of your net wealth to charity, the rate at which you are taxed on the remainder above the nil-rate band drops from 40 per cent to 36 per cent.
Those who take financial advice often up paying less tax than those who don't. But before you pay out for advice, you should consider whether you will even be caught by inheritance tax, because fewer than 5 per cent of estates are.
If you have a life insurance policy that will pay out a tax-free lump sum upon death, then it should be written into a trust — otherwise its value will be added to your estate and could push you over the nil-rate band limit.
The OTS is calling on the Government to treat all life insurance pay-outs as if they were in trust, and so not liable for inheritance tax.
Again, you should check with your insurer to see if your policy is written in trust and name a beneficiary. You can keep more of your wealth away from inheritance tax by moving it into a trust for the benefit of someone else.
Once in a trust, the assets no longer belong to you and do not form part of your estate, so usually cannot be used to calculate the tax bill on your estate.
Note that trusts may still be subject to inheritance tax to some degree and may also have capital gains consequences.
Transfers into most types of trusts can be taxed with an 'entry charge' rate of 20 per cent if before if they exceed the nil-rate band. There may be another 20% payable on death, within 7 years for gifts into certain types of trusts.
Trustees also face an inheritance tax charge of up to 6 per cent on assets above the threshold on every ten-year anniversary of the date the trust was established. They could also face an exit charge (of up to 6 per cent) when taking assets out.
If you have set up a trust for other gifts and assets, you also need to be aware of a little-known 14-year rule that means if you die within seven years of setting up a trust, other gifts made in the previous seven years also form part of the inheritance tax calculation.
It is vital you consider the details of previous gifts and the size of your estate before establishing a trust. Take specialist advice if considering setting up a trust so that it can be tailored to your particular needs and goals.
If you give away at least 10 per cent of your net wealth to charity, the rate at which you are taxed on the remainder above the nil-rate band drops from 40 per cent to 36 per cent.
Please note that we may give a tax advice but not financial advice, e.g. what to invest in.
Berry & Lamberts Solicitors are able to assist in this regard. Please contact our Private Client Team on 01892 526344 or email Anthony Kalp
The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances
