With the value of estates increasing as a result of an increase in property prices, now is a good time to look at the current Inheritance Tax rules and the changes that lie ahead.
Inheritance Tax, sometimes referred to as the voluntary tax, is a tax levied on the value of a person’s estate upon their death. Everyone has a tax free allowance (known as the nil rate band (NRB) and that is currently £325,000.) Generally speaking, you can leave assets up to that value to your chosen beneficiaries tax free. If an estate exceeds that sum, after allowing for deduction of liabilities, then a tax charge of 40% will be applied to any amount over the NRB. Spouses, civil partners and charities are exempt beneficiaries so tax is not charged on assets left to them whatever their value.
It is possible to claim a deceased spouse’s NRB where they have not used all of their allowance and this is known as the transferable NRB. For example, the husband leaves his estate to his wife and therefore does not use his NRB as a spouse is an exempt beneficiary. The wife then leaves her estate to their two children. The wife’s executors can claim two NRBs upon her death so the wife can pass up to £650,000 to their children Inheritance Tax free.
It is possible to reduce the size of one’s estate in order to reduce any liability to Inheritance Tax. Early and careful planning pays. There are a number of exemptions and reliefs as follows:
- The Nil Rate Band as mentioned above.
- Gifts between spouses/civil partners as mentioned above.
- Small gifts – there is a specific relief for small gifts totalling less than £250 in any one tax year by an individual to any one recipient. There is no limit as to the number of individuals to whom exempt small gifts may be made in a tax year but this exemption is not available against the first £250 of larger gifts.
- Annual Exemption – the first £3,000 given away in each tax year is entirely free of Inheritance Tax. The whole or part of any unused balance can be carried forward for one year only and the exemption for the current tax year has to be used first.
- Marriage gifts – gifts made in contemplation of marriage are exempt, eg £5,000 by each parent of the bride or groom, £2,500 by each grandparent or remote ancestor of the bride or groom and £1,000 by anyone else.
- Charitable gifts – gifts to charity (and to political parties) either in lifetime or upon death, are exempt without limit.
- Transfers made out of income – regular transfers which leave you with sufficient income to maintain your usual lifestyle are not eligible to Inheritance Tax, even if made within seven years of death (typically used to fund insurance premiums).
- Business Property Relief (BPR) and Agricultural Property Relief (APR) – BPR is a relief available for certain business assets/interests whereby they can be passed onto a beneficiary Inheritance Tax free, irrespective of their value. There are certain requirements that need to be met before the relief is available at 100%; the main ones being the assets/interest must relate to trading rather than investment and must be held for at least two years before the date of death. A similar relief is available for agricultural assets/interests known as APR and again there are a number of requirements that need to be met before a successful claim is made as follows; the property/interest must be owned and occupied for the purposes of agriculture for at least two years before the date of death or where the property is let for the purposes of agriculture, it must be owned for a period of 7 years before the date of death.
It is advised that those assets to which BPR/APR applies, are left to non-exempt beneficiaries or a trust for the benefit of specified persons rather than to a spouse/civil partner, in order to utilise the relief. Leaving such assets to a spouse/civil partner wastes the relief because they are exempt from Inheritance Tax in any event.
From April 2017, there was an additional Inheritance Tax Allowance known as the Residence Nil Rate band which started at £100,000 and will rise to £175,000 per person by April 2021. This additional allowance will only be applicable to a persons residence which is left to their direct descendants, such as children and grandchildren. By April 2021, this will mean that it will be possible for certain individuals to leave assets worth up to £500,000 Inheritance Tax free to the next generation and in the case of couples this sum will be up to £1,000,000.