Inheritance Tax (IHT) is one of the most unpopular types of tax in the UK and often referred to as a ‘death tax’. With the Office of Tax Simplification (OTS) reviewing it and recommending changes, it’s the perfect opportunity to look at why and what the current rules mean for you.
IHT is paid on around one in 20 estates in the UK. Whilst that’s relatively few, the bill can be significant and it’s one that your estate could be liable for without realising it, particularly when you factor in property growth. During the 2018/19 tax year, IHT receipts reached £5.2 billion following a 3.1% increase on the previous year. As a result, understanding whether your estate may need to pay IHT and what the likely bill will be is crucial for effective estate planning.
However, the rules around IHT can be complicated and this is the key reason that the review is happening.
What is Inheritance Tax?
Let’s start at the beginning: IHT is essentially a tax applied to your estate when you pass away if its total value exceeds certain thresholds. The standard IHT rate is 40% on the portion of your estate that is greater than these thresholds.
Your estate covers all your assets, such as saving accounts, investments, property and physical items. As a result, you may be underestimating how much your estate is worth, especially when you factor in growth and inflation. This can make understanding whether IHT may be liable on your estate and the size of the eventual bills difficult.
Usually, IHT has to be paid on your estate within six months of passing away. When you die, the executor values your estate and reports this to HM Revenue & Customs (HMRC), whereupon the tax should then be paid. A receipt for IHT is then issued and probate can be granted, allowing assets to be distributed according to your will or intestacy rules if you die without a will in place. Where the value of assets fluctuate, for instance, stocks and shares, the value is taken as the point of death.
Will your estate need to pay Inheritance Tax?
When calculating the potential IHT that your estate may face, there are two key thresholds to keep in mind:
1. Nil-Rate Band: You can pass up to £325,000 on to loved ones without your estate needing to pay any IHT. If the total value of your estate is above this threshold, IHT may be due.
2. Residence Nil-Rate Band: If you’re leaving your main home to children or grandchildren the Residence Nil-Rate Band can also be used. This can add up to £150,000 (rising to £175,000 in 2020/21) to the amount you can pass on as inheritance tax-free.
The Nil-Rate Bands can be used together. In effect, this means that an individual can leave up to £500,000 to beneficiaries free from IHT from 2020/21. If you’re married or in a civil partnership, it’s also possible to pass on unused allowances to your partner. So, a couple could effectively pass on an estate valued at £1 million if both Nil-Rate Bands and Residence Nil-Rate Bands are maximised.
It’s important to note that it’s often possible to reduce an IHT bill and, in some cases, it may be avoidable. However, this usually relies on you taking a proactive approach to estate planning. Among the steps that can reduce IHT are:
- Making the most of the gifting allowances to reduce the size of your estate
- Using a trust to take some of your assets outside of your estate
- Taking out life insurance to cover the costs of IHT
- Leaving more than 10% of your estate to charity to reduce the IHT rate from 40% to 36%
The best way to manage potential IHT liabilities will depend on your personal situation and what you want to achieve. If you have concerns about IHT, please contact us.
The OTS review
So, what has the OTS recommended as part of its review? Among the propositions were:
- Scrapping the current gifting rules in favour of a single, higher personal gifting allowance
- Reducing the current seven-year rule, the time period that must pass for some gifts to be considered entirely outside of your estate, to five years
- Removing the sliding scale of IHT rate that is applied when a gift has been given within seven years of death in favour of a simpler rate
- Removing IHT on death-benefit payments from life insurance companies, removing the need for them to be held in trust to avoid IHT
Whilst none of these recommendations have yet been implemented, the review does highlight how regulation and legislation can change. As a result, it’s important to regularly review your own financial and estate plan to reflect where developments have occurred.
If you have any questions relating to IHT, estate planning or your overall financial plan, please get in touch.
Please note: The Financial Conduct Authority does not regulate tax or estate planning.