How to ensure your children pay less inheritance tax, and don’t get caught out by your financial gifts.
Inheritance tax is an area we are frequently asked about. It seems to be the last area which business owners and individuals think about, perhaps because to do so we need to confront our own mortality. But isn’t it worse to work incredibly hard for many years, save your money, hoping to spend it in your retirement and pass some wealth on to your children, only to have it swallowed up in Inheritance Tax payments?
Most people have some awareness of the opportunity to make financial gifts to loved ones which will sit outside of one’s estate on death. However, only around a quarter of those who are actually making gifts appear to be aware of the risks of Inheritance Tax.
In fact, the National Centre for Social Research recently conducted an in depth study alongside the Institute for Fiscal Studies, which highlighted not only that fact, but also that only 45% of ‘Gifters’ are aware of Inheritance Tax Rules and exemptions around larger gifting.
More worryingly, only around 8% of people give any consideration to tax rules before making a financial gift – if they even associate such activity with Inheritance Tax in the first place!
So, what do you need to know about Inheritance Tax and Gifting?
The Inheritance Tax Threshold
A single person currently has a starting threshold for Inheritance Tax of £325,000. For those married couples and civil partners, this threshold is doubled to £650,00. Do be aware that for common law partners, or those living together, the doubling of the threshold does not apply.
The Residential Nil Rate Band
For those who have an estate with a value greater than £325,000, you can take advantage of the additional residential nil rate band once your main residence is passed on to your direct descendant. This threshold has increased from £100,000 in 2017-18 to £150,000 in 2019-20 and is set to increase again to £175,000 from 6th April 2020 and in line with the consumer price index thereafter.
Any unused nil rate band can then be transferred to a surviving spouse or civil partner exempt from Inheritance Tax, and you can also take advantage of this nil rate band when downsizing later in life.
However, beware – if the value of your estate is greater than £2,000,000, you should be aware of the tapered withdrawal of this additional nil rate band!
For more on this area, please consult HMRC’s guidance at the Gov.uk website.
How much is Inheritance Tax?
The standard rate of Inheritance Tax after the above thresholds have been applied is 40%.
What about Charitable Donations?
There is a reduced rate of 36% Inheritance Tax available on certain assets, should you choose to leave at least 10% of the net value of your estate to charity.
Interestingly in relation to Gifting (see below for rules), research suggests that 80% of gifts go to individuals, usually friends and family members, with 10% of gifts being donating to charities, including churches.
Gifting – The £3,000 rule
Each tax year* every individual has an Inheritance Tax free allowance of £3,000, known as your annual exemption, which can be given away without being added to the value of your estate.
You are allowed to carry any of your unused allowance forward by one year only. This does mean that in the first year you make a ‘gift’, you have an allowance of up to £6,000 in total.
Gifting – The £250 rule
You can also make gifts of up to £250 per person as many times (that is to as many different individuals) as you like in any given tax year. That is as long as you haven’t used another allowance or exemption on the same individual.
Other Gifting
There are additional rules and exemptions surrounding gifting relating to family weddings and other special occasions, gifts to charities and political parties, and gifts which help with other people’s living costs.
Timing
Timing is everything when considering gifting in relation to Inheritance Tax.
How the gifts you make to others is treated for Inheritance Tax purposes depends on how long you live following the gift in question.
If you live for more than seven years following the gift being given, it is considered to be fully owned by the person to whom you gifted it and therefore outside of your estate for Inheritance Tax purposes.
If however you were to die within three years of making a gift the full 40% of Inheritance tax applies.
Thereafter so-called ‘taper relief’ is applied, reducing from 40% to 8% if you die between 6 and 7 years of having made the gift in question.
Remember a ‘financial gift’ isn’t just cash. It can also relate to property and possessions, or items of value such as cars, jewellery, art.
Are there exemptions to the ‘Timing’ rules?
The short answer is Yes – Inheritance Tax can get complicated when individuals make larger gifts to their children. For example, should you decide to ‘gift’ your main home to your children, but then they allow you to continue to live there without paying market value rent, then that gift does not stand, and the property would be considered as forming part of your estate.
It is very important to take advice when considering making any substantial gifts, and we would recommend you do plan for your Inheritance Tax liabilities sooner rather than later.
As always, the IN Team are happy to help answer any tax related questions you may have, and to introduce you to an independent financial advisor who can help you with your retirement and Inheritance Tax planning.
Please do not hesitate to get in touch.
For more on Inheritance Tax in general, please consult HMRC’s guidance on this subject.
* The UK tax year runs from 6th April to 5th April
