Who would you like the main beneficiary to be of your assets on your death? Those of us who answer that they would like the State to inherit the largest share of their wealth after their demise would be in the minority. However this is the outcome for many estates, with Inheritance Tax (IHT) receipts reaching £4.9bn in 2017.
For a UK domiciled and resident person this tax is currently levied on chargeable assets in excess of the nil rate band at 40%. An understanding of the existing allowances and exemptions is sensible to grasp for those wanting to gain a firm grip on the options and tactics available to them to reduce the impact for their chosen inheritors.
The first point to recognise is that most individuals have an initial Inheritance Tax free allowance that currently stands at £325,000. On top of this, for those with some of their assets tied up in the value of their main residence, a further £125,000 can be inherited by their direct successors without a liability, which is due to peak at £175,000 from the tax year 2020/21. The main residence allowance is reduced by £1 for every £2 in excess of £2,000,000 on an estate.
There are further rules which will, in different situations, ease the IHT burden.
Inheritances between spouses and civil partners are exempt. One of the advantages of being married or part of a civil partnership is that you are tax immune from each other for IHT and Capital Gains Tax purposes. In this way you are free to make gifts to your significant other and assets can be passed to them during your lifetime or on death without penalty. On first death, any unused portion of their partner’s tax free allowances including the main residence enhancements will be inherited.
Some assets are exempt or partially exempt from IHT, subject to qualification rules, which can include business assets in trading organisations, agricultural land and approved pension funds. Other exemptions exist on the value of gifts made during one’s lifetime. Each tax year, £3,000 of your capital can be gifted to your chosen recipients and if you have not used this allowance in the previous tax year, you can utilise it during the current tax year. In this way, a couple can potentially give £12,000 to their beneficiaries exempt of IHT if they have not done so in the previous two financial years.
Further exempt gifts of capital can be made to other recipients each year up to £250, as HMRC do not expect us to keep records of every single gift we make at times like Christmas or for birthdays. In addition, capital gifts in consideration of a marriage or civil ceremony can be made of up to £1,000 for any individual, £2,500 in respect of grandchildren and £5,000 for children. While it is entirely legal to make capital gifts in excess of these limits to individuals it is important to keep records as such generosity is seen by HMRC as transfers of wealth which are potentially exempt on the proviso that the donor survives 7 years from the date of the transfer. Such gifts are referred to as Potentially Exempt Transfers (PETs). On survival by the transferee for 7 years, the gift becomes exempt from IHT or chargeable if the donor dies within this timeframe.
Where it can be proven that the gifts made are identifiable as being from one’s excess income, with the intention that they follow a regular pattern and are to be habitual, the above limits do not apply and these are also exempt. The definition of excess income test, to avoid the last 7 years’ worth of excess income gifts being regarded as a series of capital payments, is applied posthumously so it is very important that records and thinking in this area are robust.
In some instances it may be beneficial to consider the use of trusts which can reduce or eradicate the IHT exposure if carefully constructed. In many cases the donor will need to retain some form of access to either an income stream from the trust assets or the capital itself and great care is required in making sure that Income Tax, Capital Gains Tax and Inheritance Tax are not unwittingly triggered or exacerbated.
Gifts to registered charities remain exempt from IHT either within our lifetimes or as a legacy in our estates and where such generosity represents more than 10% of the after nil rate band assets, HMRC reduce the IHT charge to 36% as a way of encouraging altruism.
Inevitably some tax may remain chargeable on our demise and here reserving funds to help finance the liability through life insurance will help in situations where premiums are affordable. Such premiums tend to be more affordable the earlier planning is adopted.
There are many strategies that can be effective to reduce an IHT liability; by remaining in control of your wealth and ensuring tax efficiency while achieving your financial lifetime commitments and goals, you can gain the upper hand in preparing for your legacy.
Our experienced and expert financial planning team are available to help you create and hone your own wealth strategy. Please use our initial free consultation service to help put you in control.
The above comments are of a general nature and are not intended to be construed as formal individual advice.