Inheritance Tax

The Government has frozen the level at which Inheritance Tax (IHT) starts for four years. With house prices rising in some parts of the UK that could mean an increase in the 16,000 estates which paid this hated tax in 2010/11. Although people worry about IHT it is a tax that only three in a hundred estates pay. Spouses (including civil partners) can inherit everything with no tax to pay. And when a widow or widower (including civil partners) dies the heirs can benefit from the unused tax free allowance of the first to die. This change, which applies to all deaths from 9 October 2007, can double the starting point for IHT.

Limit
The threshold for paying IHT (called the ‘nil rate band’) is £325,000 for deaths which occur between 6 April 2009 and 5 April 2015. That band applies to anyone who is single or divorced (including a dissolved civil partnership). If you are married (or in a civil partnership) then you should each leave everything to the other.  No IHT will be due on the first death and on the second death the heirs will be able to benefit from a double nil rate band of £650,000. A person who is already widowed has to look at what happened when their spouse died. If their spouse left everything to the survivor the heirs will benefit from a double nil rate band. However if the first to die left some of their estate to other heirs then on the second death only a portion of the nil rate band may be inherited.

For example William and Elizabeth have been married for 30 years. William died in May 2005 and left £55,000 in cash to the children and the house and the rest of his estate to Elizabeth. In May 2005 the nil rate band was £275,000. So William’s £55,000 bequest to the children used up 20% of the nil rate band leaving 80% for Elizabeth’s heirs to use. When she dies her heirs can use her own nil rate band of £325,000 plus 80% of the current nil rate band of £325,000 which is £260,000. So Elizabeth’s heirs get a total nil rate band of £585,000. If her estate is worth less than that then no tax is due. Any remaining estate above the nil rate band would be taxed at 40%.

Spouses who have in the past separated the ownership of their home into two and plan to leave half each to their children should normally undo that arrangement. Splitting the property was good advice before the 2007 changes but no longer is. However, if either partner has been married before and would inherit some nil rate band from the death of their first partner then they should seek professional advice before making this change.

Reducing IHT
The easiest way to reduce IHT is to give money away while you are alive and then live seven years. Once that time has passed any gifts are completely ignored. However, if you die before the seven years have passed the gift will be liable to tax which would normally be paid from estate.

If you give away items but still enjoy the benefits of them they count as yours. So if you give your home to your children but carry on living there it will still be counted as part of your estate. As will a valuable painting you give away but keep on your wall.

If you give away shares or something that has grown in value since you bought it then you may have to pay some capital gains tax on the difference between the purchase price and its value when you give it away. So it is much simpler to give away cash.

Exempt amounts
You can give a total of £3000 every year without it coming into the IHT arithmetic. And if you gave nothing away in the previous tax year you can give away £6000 the next. If there is a wedding you can give up to £5000 to a child of yours or £2500 to a grandchild or great grandchild or £1000 to anyone else. The marriage exemptions are on top of the £3000. You can also give gifts of up to £250 a year to any number of people. But those beneficiaries cannot also get money through the marriage or £3000 exemption. These allowances are personal so both members of a couple can each give away these amounts and they do not count as part of their estate.

If you have an income which is more than you need to live on then you can give away the surplus if doing so will not lead to a reduction in your lifestyle. This exemption is particularly useful to a widow who has inherited a good pension from her husband and finds that she consistently spends less than her income. She can give away the surplus without it counting as a gift when IHT is calculated on her death.

You can also give money for the maintenance of certain people free of IHT. Gifts to maintain your ex-spouse (or civil partner) or a relative who is financially dependent on you are exempt. Gifts to maintain your own children (but not grandchildren) are exempt while they are in full time education. So if a parent pays off a student loan or tuition fees that should be exempt as long as they are in full time education when the gift is made (in practice by 5 April after they finish their course.)

With all these exemptions it will help your executors to make a note of what you are doing and any supporting evidence and keep the documents with your will.

Other exemptions
If someone dies due to their service in the armed forces their estate is completely free of IHT. The exemption can be used even if the death was hastened or partly caused by their service. It can be claimed at any time, even years after the death, if IHT was paid on an estate.

If you have a life insurance policy which pays out on your death then the proceeds will normally form part of your estate. However, you can avoid IHT by getting the policy ‘written in trust’. That means the trust gets the money and then gives it to the heirs bypassing IHT. The same can be done for insurance paid as part of a pension. Your insurer or financial adviser can tell you how to get the policy written in trust. For very large life policies some tax may be due when the trust deed is signed and every ten years thereafter.

In the 2011 Budget the Chancellor introduced a complex rule to cut the IHT on estates where the will leaves at least 10% of the taxable part of the estate to charity. From 6 April 2012 the IHT on the remainder of the estate will be cut from 40% to 36%. So if your estate is large and you intend in any case to give at least 10% of the amount above your nil rate band to charity your heirs will benefit from this change.

e-mail Paul Lewis on paul@paullewis.co.uk