Inheritance Tax: Make Sure You Don’t Get Caught Out – Part 1
Inheritance Tax (IHT), once only the bane of the wealthiest, is now a charge that affects a wide cross-section of society. Complex rules and criteria around reliefs and exemptions can mean that even fairly modest estates, if they contain the ‘wrong’ type of asset, could be subject to IHT.
The current rate of IHT is 40%. However, there are rumours of future changes following recently published government requested reviews. In addition, there is growing pressure to increase tax revenues due to the unprecedented spending during the Covid-19 pandemic. This all adds up to a great deal of uncertainty for the future of how wealth will be taxed.
In this, article we explain the basics of IHT, how it is charged and the main reliefs and exemptions available.
What is Inheritance Tax?
IHT is a tax applied to your estate on death. Currently it is payable at 40%. It also applies to some lifetime transfers, eg. transfers into a discretionary trust, and gifts made in the seven-year period to your death. The tax can apply to all types of assets owned at death such as land and property, investments, cash, jewellery, art and vehicles.
For many individuals, the various exemptions and reliefs available will result in no IHT reporting or tax payable. However, with rising house prices and general inflation affecting all types of assets, many more people should consider their own position through the prism of IHT.
Exemptions and Reliefs
This is the most commonly used exemption and automatically applies on death. Any part of an estate left to a spouse or civil partner will be exempt from IHT. So when considering a couple’s wealth, any IHT liability usually only occurs when the second person dies. This leaves any unused standard nil rate and residence nil rate bands available to be used on the second death.
Nil Rate Band (NRB)
Everyone currently has a NRB of £325,000. This means that there is no IHT payable on the first £325,000 chargeable assets of your estate. Where the NRB is not used, for example when all assets have been left to a spouse, the NRB can be transferred and used on the death of the surviving spouse. This means a couple’s IHT cumulative NRB allowance is effectively £650,000.
Residence Nil Rate Band (RNRB)
This is a relatively new exemption introduced in April 2017. It acts as a top-up to the NRB and applies where the deceased has an interest in a qualifying property and this is passed on death to a direct descendent eg. child, stepchild or grandchild. The RNRB is currently £175,000 but is restricted for those with an estate value (before any reliefs) in excess of £2 million and is completely lost for estates valued at £2.35 million or above. Like the NRB, any unused RNRB can be used by the surviving spouse on their death. However, the level at which the exemption is restricted is not doubled. This could mean that couples who have left all assets to their spouse may find that the surviving spouse is left with an estate valued in excess in £2 million and thereby risk restricting or completely losing RNRB, unless some IHT planning is considered.
Used jointly, the NRB and RNRB results in couples with a qualifying residential property with a value of at least £350,000 being able to pass on up to £1 million of their estate (including the property) free of IHT.
Gifting to Charity
Any gifts left to charity will not be subject to IHT. In addition, you can reduce the rate of IHT payable from 40% to 36% by leaving at least 10% of your net estate to charity.
Agricultural and Business Reliefs (AR and BR)
These are extremely valuable reliefs available to those with agricultural or business assets. AR and BR provide either 50% or 100% relief on the agricultural value of qualifying agricultural assets, in the case of AR, and the market value of qualifying business assets, in the case of BR. These are extremely complex reliefs so we advise you take appropriate advice from a qualified professional if you believe they are relevant to your circumstances.
The need for IHT Planning
As professional advisers we see IHT planning becoming increasingly important to our clients. As the value in investments and property has increased, particularly over the last decade, more of our clients are finding that their estates are likely to be liable to IHT.
Although the morality around paying tax on wealth is a hotly contested topic, in general most people want to pass on as much of their wealth as possible to loved ones. It is important to look at your IHT position from not just a tax perspective; you should take into account other practical considerations such as long-term care and your income needs in retirement.
At GWA, when carrying out an IHT review the first thing we do is talk to our clients about the future. Its so important to listen to people’s hopes and wishes for themselves and their loved ones. We know it can be difficult discussing your own mortality. However, starting the conversation as early as possible can allay worry and fear for you and your family.
If you would like to know more about IHT why not read our follow up article when we consider the planning measures that can help you to reduce your IHT liability and pass your estate on to your loved ones as you intend.
The information in this article is general and is not tax advice. If you would like advice for your own personal circumstances, please get in touch with us.