Inheritance Tax: how does it affect you?
Benjamin Franklin: “In this world nothing can be said to be certain, except death and taxes.”
These days I seem to be getting an increasing number of questions from clients worried about the possibility if incurring Inheritance Tax (IHT). These questions range from could it possibly affect me, to how can I avoid it?
It’s a tax that most people are remarkably ignorant about, but with increasing numbers of middle aged people inheriting their mum or dad’s house, it’s a problem that is only likely to grow.
- Tax on Relatives named in your will
- Enduring Power of Attorney
- Property Value Increases
- Tax Relief on Charity Donations
- House Deposit Donations
- University Provision for Grandchildren
- Death In Combat Provisions
First a brief summary of the tax:
What is Inheritance Tax?
Inheritance Tax may be payable on a person’s estate, which is the total value of what they leave behind, following their death. IHT is only payable after any debts and funeral expenses have been taken off and it’s only payable if the person’s estate exceeds £325,000 (known as the nil rate band).
If you are married and die before your spouse, your £325,000 nil-rate band will be added to your wife or husband’s, meaning that his or her estate will then have a £650,000 nil rate band. Additionally, an exemption exists for gifts of up to £3,000 in each tax year, as well as modest gifts to individuals and some wedding gifts.
Tax on Relatives named in your will
Question 1: I made a gift of £100,000 to my son in June of this year, when will it be exempt from IHT?
Answer: Any gift becomes free from IHT seven years after it’s made (that’s calendar years not tax years), so as long as you survive until June 2021 he won’t have any liability. If however you’re unfortunate enough to die during the 7 year period any tax is reduced pro rata; in other words every year you survive the potential tax goes down by one seventh.
Enduring Power of Attorney
Question 2: My mum recently had to go into a residential care home because of her deteriorating health. I have an enduring power of attorney (EPoW) and wonder if I can continue making her annual £3,000 gifts, which she’s done for the last ten years or so?
Answer: Any habitual gift to family, friends or charities can be continued by you under the EpoW rule, subject to the 2005 Mental Capacity Act, however in the circumstances you’ve described there shouldn’t be a problem.
Property Value Increases
Question 3: My husband died 8 years ago, the house was valued for probate at £245,000 and I transferred it into the names of my two children on the basis that I could live in it rent free until I died or went into a home permanently. The house is now worth around £400,000 and I want to know what else I need to do to avoid any tax for my children?
Answer: This type of gift is classed as “A Gift With Reservation” and different rules apply. HMRC are likely to include it in your estate for IHT purposes. The second complication is your children could also face a potentially large Capital Gains Tax liability as it is not their main residence.
My suggestion is to immediately start paying a reasonable rent which would get round the IHT problem; however your children would have to pay tax on the income. The amount of CGT payable would depend on when it was sold, the size of the gain and your children’s circumstances at the time.
Tax Relief on Charity Donations
Question 4: I’m in the process of rewriting my will and want to donate a substantial amount to a local animal rescue and welfare charity; are there any reliefs for charitable donations?
Answer: Yes there are; any bequest to a charity does not form part of your estate for IHT purposes and if the bequest is 10% or more of the estate the rate of IHT payable on the balance is reduced from 40% to 36%.
House Deposit Donations
Question 5: My recently married daughter and her husband are in the process of buying their first house and both his parents and my wife and I want to help them by each family contributing £10,000 to their deposit. I have not previously made any money gifts, but am concerned that if I were to die prematurely, my daughter may have to pay IHT on the gift. Is there anything I can do?
Answer: For a start, your £10,000 gift in itself does not have any immediate tax implications for either you or your daughter. Also because you did not make any gifts last year, your £3,000 allowance can be rolled over and added to this year’s allowance, thus making £6,000 free of any potential IHT. Finally as you are married and presumably your wife agreed to the gift, she also has the same allowance and can utilise that to effectively reduce any potential IHT liability to nil.
University Provision for Grandchildren
I do practice what I preach
Question 6: I’m changing my will as I now have grandchildren and want to ring-fence part of my estate to benefit them when they hopefully go to university. Is there anything I can do to avoid them potentially losing 40% of the bequest in Inheritance Tax?
Answer: Yes there is; but not by way of your will. What you need to do is set up a Beneficial Trust, which can either be a lump sum or regular contributions if you’re still working. This way the capital sum in the Trust does not form part of your estate for IHT. Also, if you wish you can either have any growth/interest in the Trust paid to you as income whilst you’re still on this mortal coil, or you can ask for it to be re-invested to boost the eventual pot.
Death In Combat Provisions
Question 7: I’m a Senior Warrant Officer in the RAF and in my early 50’s; I have just heard that I’m being sent to Baghdad as part of a logistical support unit. As a result I’ve decided to review the arrangements I have in place in case the worst happens. I am a widower and own two properties, plus fairly substantial savings and the total estate is worth around £600,000. Can you advise whether I should start making regular gifts to my children and grandchildren, or is there any other strategy you could advise to mitigate the probable IHT bill?
Answer: Worry not; if you are unfortunate enough to be killed whilst in the war zone you’re being posted to, there is a little known exemption available. If your death is as a result of wounds inflicted or as a result of an accident occurring while you’re a member of the armed forces and engaged on active service; it is probable that your estate will qualify under Section 154 of the Inheritance Tax Act 1984 to be exempt from Inheritance Tax. In such cases the executor or administrator should contact the Ministry of Defence for a certificate of exemption.
Assuming the more likely scenario that you survive, then yes, gifts are a good way to gradually reduce the value of your estate. Gifts of up to £3,000 in each tax year are exempted and any number of small individual gifts, of up to £250 each are also exempt. Additionally you can make a wedding gift of up to £5,000 as a parent or £2,500 as a grandparent; and if you wish to make any gifts to charities, a political party or a museum or university, these are also exempt.
David Jones Tax Accountant
Further information on IHT can be obtained by calling the Probate and Inheritance Tax helpline on 0845 30 20 900. There is also a Customer guide to Inheritance Tax on the HMRC website at www.hmrc.gov.uk/cto/customerguide/page4.htm
If any of you would like more detailed information on any aspect of Inheritance Tax, send me an e:mail and I’ll be pleased to advise further.
David Jones is the Senior Partner and Founder of Morgan Jones & Company. Born in Liverpool and an Accountancy graduate of the University of Wolverhampton, David spent twenty years working for the Customs & Excise in London then Shrewsbury before starting his own business. David's depth of knowledge of the UK tax system and his ability to communicate this learning has seen Morgan Jones & Company grow into Shropshire's most respected Accountancy Practice.