Former Labour Chancellor Roy Jenkins famously described Inheritance Tax as ‘a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue’.
When Gordon Brown was Chancellor of the Exchequer, he called IHT a “voluntary tax” because he said there were many ways to avoid it.
If not planned appropriately, inheritance tax can fall negatively on your loved ones and have a detrimental impact on their finances as a result of reduced assets passed down to them after you die. Having an understanding of inheritance tax can make your estate planning easier and relieve unnecessary stress and costs.
Not familiar with inheritance tax and its importance? We’ve run down the basics of inheritance tax and the vital importance of inheritance tax planning when estate planning.
What is inheritance tax?
Inheritance tax is the tax on the estate of someone that has passed away. The estate could be property, money or any other possessions passed down in a will, after debts have been minused.
If you plan to pass assets down after you die, your family or heirs could face a tax bill or deductions from your estate, in the form of inheritance tax. The cost of inheritance tax can be thousands of pounds, depending on the size of your estate. It is possible to reduce these tax bills and in some cases, pay no inheritance tax at all with effective inheritance tax planning.
How does inheritance tax work?
The way inheritance tax works depends on who is receiving the assets and how much the assets are worth.
What is the inheritance tax rate?
As of the 2021/22 tax year you have £325,000 worth of tax-free inheritance tax allowance, which is also known as the nil-rate band. So if you’re leaving £325,000 or less, you won’t be paying an inheritance tax rate. If you are leaving your home to a direct descendant (child or grandchild), the tax-free threshold is also increased via the Residence Nil-Rate Band.
The standard inheritance tax rate for anything over the £325,000 threshold is 40%.
If you are married and all the assets are passing to each other on death, the remaining spouse will inherit both nil-rate bands on first death (subject to previous gifts etc). This means that on second death there is an inheritance tax allowance of £650,000.
The Residence Nil-Rate Band.
Introduced in April 2017, the Residence Nil-Rate Band provides an additional allowance on death for those leaving properties to a direct descendant.
This means that for a married couple they could potentially have an additional £350,000 allowance (if their property is valued at that amount) as long as it is their children or grandchildren who inherit the property. This would take their total inheritance tax allowance to £1,000,000.
If your property is worth, for example £250,000, then you would get an additional allowance of this amount as a married couple.
Single person allowances differ.
Each person has an annual gifting allowance of £3,000 per year. This is your annual exemption and isn’t included in any inheritance tax calculations. If you have not used the previous year’s allowance, it can be carried forward to the following year.
Husband and wife have a £3,000 allowance each so £6,000 could be gifted each year without consideration of the 7-year rule.
Smaller gift allowance for events like weddings are also permitted.
Gifting and the 7-year rule
An excellent way of reducing your inheritance tax liability is to gradually gift your assets away. Any gift has to be at arms length, which means that you cannot benefit from this money once you have given it away.
If you have an inheritance tax liability then your gifts will be subject to the 7-year rule. Once 7 years lapses since the gift then it is classed as outside your estate for tax calculations. If you gift some money and pass away within 7 years then the amount of tax that you pay is tapered.
If you do not have an inheritance liability, your executors will still need to record details of your gifts on probate / inheritance tax forms. However, once they are brought back into the calculations there will still be no tax to pay. Therefore, the 7 year rule has less of an impact.
How can you reduce your inheritance tax rate?
It is possible to avoid inheritance tax completely, or at least reduce it. Gifts between spouses and charities are often tax-free as well as other gifts in the run up to your death. Insurance policies and trusts can also help to reduce your tax rate.
With enough planning, there are lots of avenues available to mitigate inheritance tax. Even if you feel it is too late, there are planning aspects you can consider. Paying inheritance tax is not a foregone conclusion.
Who pays the inheritance tax bill?
Usually, money from your estate is used to pay the inheritance tax bill, directly to HMRC. It is the responsibility of whoever is dealing with your estate after you die to organise this. This could be an executor defined in your will.
The people who inherit from your estate won’t normally pay any inheritance tax on what they have inherited but other taxes may come into play if they inherit different types of assets such as a house. If you have given gifts to people in the last 7 years before your death, they may have to pay some inheritance tax on these but this depends on the amount and when they received these gifts.
There are other types of inheritance tax relief and deductions too such as business relief and agricultural relief.
Inheritance tax planning at Oakworth
Due to the complexity of inheritance tax, it is recommended that if you have an estate to pass down, it would be wise to obtain estate planning and inheritance tax planning advice. This can be the ideal way to work out the best way to pass your inheritance down to your loved ones and beneficiaries, reducing stress and unnecessary costs. Where possible, plan in advance.
Oakworth financial planning can help you with estate planning. We have years of experience dealing with inheritance tax and a wealth of knowledge on inheritance tax allowance and rates, for all circumstances. We also keep up to date with the latest tax rates and allowances from the government.
Get in touch today to start your estate planning journey.