Inheritance tax is becoming more and more of a ‘tax bombshell.’
This is purely because property prices have increased so much over the past few years. If you do not plan for IHT now, then you could be passing on a huge tax liability as well as unwanted stress to your loved ones!
In this section you will become familiar with IHT and what you can do to minimise any future liability.
What is Inheritance Tax?
Inheritance tax is commonly referred to as a ‘gift tax’ or ‘death tax.’
If at the time of your death you pass on part or the whole of your estate, then the inheritor could be liable to pay inheritance tax.
There is currently an IHT threshold level of £325,000 that has been effective since the 2009–2010 tax year. This nil rate band will be frozen, and will remain at £325,000 until April 2026. Anything above this amount is taxed at 40%, i.e., at the highest rate.
This means that if someone died after the start of the 2011-2012 tax year and the whole estate is valued at less than £325,000, the inheritor will have no inheritance tax to pay.
If the value of the estate is over this amount, then anything above the £325,000 will be taxed at 40%.
The March 2011 Budget announced that from April 2012, a reduced rate of IHT of 36% will be introduced where 10 per cent or more of the net estate is left to charity.
No IHT Liability – Example
At the time of his death, John has an estate that is worth £240,000. His estate is made up of his house, which is worth £200,000, and the £40,000 cash in his savings account.
He gifts his entire estate to his son.
His son will have no IHT liability as it is below the threshold level.
Property Price Increases
Now, given the property price increases over the past few years, this threshold level seems to be very low.
If parents living in London, and the southeast in particular, were to pass away today, then it is highly likely that they would trigger an immediate tax liability on their loved ones.
This is because a very large number of properties in these areas are already valued at above the IHT threshold level!
This means that more and more people are going to be subject to this tax liability in the future.
One VERY Important Point To Note!
If you die tomorrow and leave the estate to your children, then any IHT liability is due immediately by them.
IHT Due at Time of Death – Example
Death befalls Albert. When Albert died, he left everything to his son.
At her time of death, the estate is valued at £425,000. The son must pay £40,000 in taxes before he can take ownership of the estate.
This is because he is liable to pay tax at 40% on the £100,000 value of the estate that is above the £325,000 threshold level.
If the estate was made up entirely from the value of the property, in which the son lived, then it may well be the case that the property will need to be sold in order to pay the tax liability!
Not only is there a significant tax burden, but there is also a huge inconvenience for the son.
FOUR Simple Ways To Reduce Inheritance Tax
There is no IHT liability if a spouse inherits assets from their partner. This is regardless of the value of the inheritance
Here are four common ways of reducing inheritance tax.
- Utilising the £325,000 threshold level
If circumstances are such that your estate is not worth more than the current threshold level, then as mentioned earlier, there is no tax liability for the inheritor.
However, as we have seen earlier in this section, this scenario is becoming more and more unlikely!
- Gifting to spouse
All gifts between husband and wife are exempt from tax as long as they are both domiciled in the UK.
This means that even if a husband has an estate valued at £10 million, then he can gift this to his wife.
It does not matter if it was gifted during his lifetime or at the time of his death; either way, his wife will incur no tax liability.
- Gifting as soon as possible during your lifetime
During your lifetime, it can be tax beneficial to gift sooner rather than later. This is especially the case if you know who will inherit your estate.
If you gift during your lifetime, then your inheritor will be in possession of a potentially exempt transfer (PET).
A PET is a lifetime gift to an individual. If someone makes PETs amounting to any figure, then there is no lifetime IHT to pay, and if they survive for seven years after the last of those PETs, then there is no IHT to pay on death either.
Note: The longer you live, the less tax your inheritors will have to pay.
So, if you transfer a property or gift it away and survive for seven years, then the inheritor will have no IHT liability.
You have already learned that husband and wife incur no IHT liability when gifting to each other.
However, if you want to gift to your children/relatives, then setting up a trust may be the best option.
Trusts can be used to hold properties as well as other appreciating assets such as stocks and shares. Properties can be placed into trusts in a tax efficient manner, which can help to significantly reduce and even avoid capital gains or inheritance tax. There are a number of different types of trusts that can be set up to make tax savings, and each have their own merits and are suitable for different scenarios.
It is strongly recommended if you are considering transferring to your children or other members of your family that you take tax advice from a tax expert.
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