Inheritance Tax Planning
Inheritance Tax, which is commonly shortened to 'IHT', is the tax paid based on the value of a person’s total estate after any allowable deductions have been taken off.
Depending on the prevailing level set for the IHT threshold (for the tax year 2020/2021 no IHT is payable on the first £325,000 of someone’s estate) a person’s Estate owes tax at 40% on anything above the threshold. This excludes the main residence allowance (see RNRB below), which can increase the limit to £500,000 (2020/2021) for estates valued at up to £2,000,000.
Far too many people, unfortunately, still don’t realise (or perhaps just don’t think about) how much IHT is going to potentially cost their loved ones when they pass away. This is a great pity as planning sufficiently well advance can minimise (even eliminate) – quite legally – the amount payable.
There are many tried and tested methods of reducing potential IHT bills BUT the key to it all is the effective use of the various legal exemptions and these all take time to work - e.g. the Potentially Exempt Transfer (“PET”) rules rely on a person surviving for 7 years after making a gift to children.
What is the Main Residence Band?
The Main Residence Band was only introduced in the 2017/18 tax year and is known as the residence nil rate band - shortened to RNRB. It can only be claimed on a main residence and can be taken into account when calculating whether IHT is applicable under the qualifying circumstances. The UK Government website (GOV.UK) has an RNRB calculator which can be a useful tool for working out what additional relief may be applied to an estate.
Are there any exemptions from IHT?
Yes, those serving in active service, such as the armed forces, police, firefighters, paramedics and humanitarian aid workers, are exempt from paying IHT if they die in active service.
Am I exempt if married or in a civil partnership?
If a person passes away and, at the time of their death, they leave assets to a spouse or registered civil partner who is resident in the UK then they are exempt from IHT. However, this is a complex area and IHT can be payable on the death of the second person. For example, if a couple have £500,000 each (or as their 'share' of a total) and one dies leaving everything to the other, then no IHT will be payable at the time as the 'value' (be it money, investments and/or property) has been left to an exempt partner even though it exceeds the £325,000. But, the survivor now has £1,000,000 which when they die will attract an IHT bill of 40% of £500,000, i.e. £200,000 (and this assumes the full use of the RNRB).
Is there anything that can be done to avoid this tax?
In the example above, even taking a worse case scenario, if £325,000 had been left to a trust on the first death (we will ignore any constructive use of RNRB) that would attract no tax. The survivor then would have only £675,000 in their estate which on second death would attract an IHT bill of 40% of £175,000, i.e. £70,000 (assuming we now use RNRB to make the threshold £500,000). To make these arrangements we would have charged around £2,000 and the estate would have saved £130,000 in IHT, a net saving of £128,000. In reality, and depending on circumstances and health of the survivor, we would probably have been able to reduce the IHT to zero on second death by various other means a little to complex to go into on a website, but entirely legal and ethical nonetheless.
When should you start thinking about IHT?
Even without ever speaking to you, we already know the correct answer is now.
As mentioned above, IHT is a tax that can be largely avoided in the majority of cases if mitigation is planned sufficiently well in advance of death: seven years plus is best but even a year before could still result in some tax savings. If your estate is valued at more than the current threshold (£325,000) it is best to get advice early on, so that plans can be put in place.
Please note that figures used above are for the purposes of illustrating how IHT works and as such we have kept them very simple. In reality matters are often more complex and so the examples given should not be taken as necessarily indicative of what an estate may actually pay. For example, some of the assets, like a life assurance policy, may be written into trust already or an account may be held jointly meaning that it can't be left on first death as it would automatically go to the joint holder et cetera. Every estate is different and that is why specific personal advice is so important.