Guide to Inheritance Tax & Estate Planning
(And how you may be able to mitigate any liability – Part 1)
Inheritance Tax (IHT) – what is it?
Inheritance tax is a 40% tax applied to estates worth over £325,000 after a person dies. The £325,000 threshold is potentially higher where the individual has inherited a partner’s exempt amount, or if a home is left to children or grandchildren.
1. What’s included in the estate?
The value of your estate for the purpose of inheritance tax includes:
2. Understanding the nil-rate band
There are several rules and exceptions regarding Inheritance Tax meaning it can get quite complicated, however, understanding the nil-rate band is key.
The nil-rate band is effectively a personal IHT allowance. Everyone receives their own £325,000 nil rate band and will only be liable for Inheritance Tax on the value of their estate that exceeds this value. Any unused percentage of the allowance can be passed on to a surviving spouse and would be claimed on the second death.
If you leave your main property to your children or your grandchildren (including adopted, foster or step-children), you may gain an additional IHT-free allowance of £175,000 which can be offset against the value of the property also referred to as the Residence Nil Rate Band (RNRB). This additional exemption will also be available where someone who has died sold their home or downsized on or after 8 July 2015.
In summary, a person can pass on up to £500,000 completely free of IHT and the combined allowances for a married couple is £1,000,000.
However, It is important to highlight that some of wealthiest estates may not be able to benefit from the RNRB. Estates worth over £2,000,000 will start to lose the RNRB, as it will be withdrawn at a rate of £1 for every £2 over £2,000,000.
This means that based on the RNRB figure of £175,000 in 2022/23, there will be no RNRB if the estate exceeds £2,350,000 for an individual or £2,700,000 for a married couple.
3. What’s exempt from Inheritance Tax?
impact on your standard of living are normally exempt from IHT. (This exemption is often used to make regular monthly contributions into investments vehicles for children/grandchildren.)
It is good practice to keep a record of gifts you make and which exemptions you are using. This will make the administration of an estate on death much more straightforward.
If you make other outright gifts to an individual, these are deemed to be Potentially Exempt Transfers (PETs). If you survive for more than seven years from making the gift, then the transfer is free of IHT and is not included in your estate on death.
On death within seven years of making a PET, the value of the PET is included in the estate calculations and uses the Nil Rate Band before it is applied to the rest of the estate. If the value of the ‘failed’ gifts, when added to any earlier gifts within seven years exceeds the £325,000 tax-free limit, IHT will become payable.
Please be aware an individual receiving the gift is primarily responsible for paying the IHT on a failed PET.
In simple terms, if you make a gift and live for a further seven years, that gift will not form part of your estate. If you do not survive the seven years, the amount of the gift will be brought back into the calculation, potentially resulting in an IHT liability on the amount gifted.
Once a gift has been made, you no longer have access to the capital nor can you derive any income from it. If those rules are breached, the gift runs the risk of falling foul of the ‘Gift with Reservation’ rules and it may remain within your estate for IHT purposes.
Lifetime gifts are often seen as a simple way to reduce inheritance tax, but as you can see above, it’s a complicated matter that needs serious thought.
As well as ensuring you abide by the rules, you’ll need to consider the affordability of giving gifts, without leaving yourself short in your later years – when you may need to pay for added expenses such as care or enhancements to your home.
You’ll also need to think about when you want your beneficiaries to gain access to the assets you gift them. For instance, you may want to give money to your children or grandchildren but retain control over what age they receive it. This can usually be done by placing the money into a trust.
Inheritance Tax can be a complex subject and it is important to seek professional advice along the way from an Inheritance Tax and estate planning specialist. Five Wealth Ltd offer independent financial advice to a wide variety of clients, at various stages throughout their investment and retirement planning journey. If you feel that our expertise would be beneficial to you, please get in touch.
Please keep an eye on our blog posts/Linkedin to see part 2 of this ‘Guide to Inheritance Tax & Estate Planning, focusing on the different options for those looking to mitigate IHT.
The information featured in this article is for your general information and use only and is not intended to address your particular requirements. It is based upon our understanding and interpretation of HRMC practice and current legislation Always obtain professional advice before entering into any new financial arrangement.
The Financial Conduct Authority does not regulate tax or estate planning. Levels, bases of and reliefs from taxation may be subject to change and their value depends on your individual circumstances. Some IHT planning solutions may put your capital at risk so you may get back less than you originally invested.