Inheritance tax is often described as the most hated of taxes. This is because, in most cases, it’s a tax on assets people have built up during their lifetime that they’ve already paid tax on.
What is Inheritance Tax?
Inheritance Tax is paid on an estate when someone dies. The rate of Inheritance Tax is 40%, but it is only paid on estates worth more than £325,000. This limit is expected to rise over time, but has been kept at this level until the tax year 2017/2018.
It is also possible for married couples and civil partners to transfer their allowances to each other when one dies. This means the limit is effectively £650,000 in this example.
How can you escape paying Inheritance Tax?
Even if your estate is over the limit, there are ways you can pass on assets without paying Inheritance Tax. For example:
- Leave your estate to your spouse (or civil partner). You won’t normally pay Inheritance Tax on anything you leave to your spouse or civil partner (though they may be liable to pay Inheritance Tax on their death).
- Donations to charity. Any payments you make to a UK registered charity will avoid Inheritance Tax. You can also qualify for a 10% discount on Inheritance Tax if you leave 10% of your net estate to charity.
- Make ‘gifts’ during your lifetime. Any gifts you make during your lifetime will not be liable for Inheritance Tax if you survive for seven years after making the gift. There is no limit of the amount you can transfer in this way. The technical name for this is a ‘potentially exempt transfer’.
- Give away money or make gifts each year. There are two ways you can do this:
- Annual exemption. You can give away up to £3,000 every year. You can also use any unused allowance from the previous year, so you can give away up to £6,000 if you didn’t make any gifts last year.
- Small gift exemption. You can make small gifts of up to £250 to as many people as you like.
For most people these are the main ways to pass on assets without paying Inheritance Tax. There are others (you can make gifts to people who are getting married or entering into a civil partnership) and there are exemptions if you own a farm, woodland or National Heritage property.
‘Pre Inheritance’ is the term being used to describe the increasing number of parents who are helping their children get a foot on the housing ladder by passing on part of their estate before they die to help pay for the deposit on a first home. So long as you survive for seven years after making the payment there will be no Inheritance Tax payable on the amount ‘gifted’ in this way. After three years the Inheritance Tax rate starts to reduce.
A word of warning: While this is an excellent way to help your children buy a first property, remember that once you give the money away it is no longer your money and you have no control. For example, if your children are married, the money would be included in the marital assets in any divorce and so your child’s ex spouse could end up with half of the money!
If you are considering giving away assets during your lifetime, but still need an income from these assets then there are more complex ways to achieve this using specialist vehicles like a discounted gift or loan trust.
What’s more, discretionary trusts can be an effective way of mitigating the costs of long term care. A discretionary trust is a trust where no one has an absolute entitlement to income or capital from the trust (this is decided by the trustees). You see, if you need local authority assistance to help fund care, assets set aside in a discretionary trust would not be included in assessing whether you qualify for financial assistance.
If you are interested in finding out more about these vehicles, we recommend you take professional advice.
If you need more general information on Inheritance Tax, click the link below.