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Inheritance Tax (IHT)

Plan to legally save £100,000s on your estate

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Sam | Edited by Johanna

Updated May 2018

IHT coins

Inheritance tax can cost loved ones hundreds of thousands in the event of your death, yet it's possible to legally avoid huge swathes of it, or possibly pay none at all.

The most important thing to do is examine whether you'll pay inheritance tax and what to do about it; and this Q&A guide is here to help you do just that. This includes Government changes giving people an extra property allowance.

What is inheritance tax?

Q and A guideInheritance tax is the tax paid on assets (after inheritance tax allowances are deducted) left when someone dies.

As Benjamin Franklin said, the only things certain in life are death and taxes, and inheritance tax (IHT) touches on both.

How does inheritance tax work?

When you die, the Government assesses how much your estate is worth, then deducts your debts from this to give the value of your estate. Your assets include:

  • Cash in the bank
  • Investments
  • Any property or business you own
  • Vehicles
  • Payouts from life insurance policies

The BIG question... how much tax do you pay?

Your estate will owe tax at 40% on anything above the £325,000 inheritance tax threshold when you die (or 36% if you leave at least 10% to a charity) – excluding the 'main residence' allowance (see below).

Dealing with it is one of the biggest single MoneySaving things you can do, as some simple actions can save you £100,000s. Yet sadly many people ignore it, either not wanting to consider the future or simply unable to broach it with relatives for fear of seeming grasping.

IHT to be scrapped on up-to-£1m homes by April 2020

Former Chancellor of the Exchequer George Osborne revealed in July 2015's Summer Budget that he'd scrap the duty when parents or grandparents pass on a home worth up to £1 million (£500,000 for singles). This is being phased in gradually until April 2020.

However, the way this works in practice takes some explaining...

The basic allowance is unchanged

The current allowance whereby no inheritance tax is charged is on the first £325,000 (per person) of someone's estate – which is the value of their total assets they leave behind when they die. Couples can leave a home worth £650,000 without it attracting inheritance tax (singles £325,000). Above the threshold, the charge is 40%. This remains unchanged. What has changed is the introduction of a new 'main residence' band.

How does the new 'main residence' band work?

New for the 2017/18 tax year was the additional 'main residence' allowance. It is only valid on a main residence and where the recipient of a home is a direct descendant (classed as children, step-children and grandchildren). This is gradually being phased in as follows and is what you'll get on top of your existing allowance:

  • For this tax year it's starting at £125,000 (meaning a total allowance of £450,000), rising by £25,000 each year till it reaches £175,000 (meaning a total allowance of £500,000) in 2020.
  • So now the maximum that can be passed on tax-free is £900,000 for married couples or those in a civil partnership, £450,000 for others. For singles, this is made up of the existing £325,000, plus the extra £125,000. For couples, when the first one dies their allowance is passed to the survivor, so that £450,000 is doubled to £900,000.
  • In 2020, the tax-free amount will rise to £1 million for couples (made up of £325,000 x 2 plus £175,000 x 2) and £500,000 for singles (made up of £325,000 plus £175,000), as the main residence allowance rises.
  • On properties worth between £1 million and £2 million, inheritance tax will be paid as normal on the amount above the tax-free amount.
  • On properties worth £2 million or more, homeowners will lose £1 of the 'main residence' allowance for every £2 of value above £2 million. So for a couple, properties worth £2,350,000 or more will get no additional allowance.

Who pays inheritance tax?

40% over the thresholdIn the 2018/19 tax year, everyone is allowed to leave an estate valued at up to £325,000 plus the new 'main residence' band of £125,000 giving a total allowance of £450,000.

For estates valued under this their beneficiaries won't pay inheritance tax. The amount is set by the Government and is called the nil-rate band, because it's the amount you pay a 'nil-rate' of IHT on.

Above that amount, anything you leave behind is subject to tax of 40% (or 36% if you leave at least 10% of your assets to a charity).

So for example, if you leave behind assets worth £500,000 (assuming you have just one property), your estate pays nothing on the first £450,000, and 40% on the remaining £50,000 – a total of £20,000 in tax – if you're not leaving anything to charity.

Officially, the £325,000 limit has been frozen until at least 2020/21, while the additional main residence allowance will be phased in until April 2020.

Exemptions from inheritance tax

People in certain 'risky' roles are exempt from paying inheritance tax if they die in active service. Included in this are armed forces personnel, police, firefighters and paramedics, plus humanitarian aid workers.

The exemption also comes into play if a person who was injured on active service has their death hastened by the injury, even if they're no longer on active service.

Why do we have to pay IHT?

The politics of inheritance tax are among the most controversial around; just ask the pre-Revolution French aristocracy!

The idea is that without it you perpetuate inherited wealth, so the children of the rich stay rich. Inheritance tax redistributes income so some of the money goes to the state to be distributed for the benefit of all. The argument against it is that when money's earned, tax is paid at the time, so to pay tax on it again isn't fair.

After years of rocketing house prices, many more people have been caught by the inheritance tax threshold, raising it higher up the agenda. Yet whatever your views politically, inheritance tax is a financial fact, so it makes MoneySaving sense to know how it will affect you, and whether you can soften the blow.

Am I exempt if I'm married?

your spouse is exempt from IHT When you die, any assets left to your spouse or registered civil partner, provided they're living in the UK, are exempt from inheritance tax. On top of this, your partner's inheritance tax allowance rises by the proportion of your allowance that you didn't use, meaning together a couple can currently leave £900,000 tax-free.

This can sound complicated, so here's an example:

Mr and Mrs Youngatheart have assets worth £900,000 between them. Mr Y dies first so his £325,000 tax-free allowance is passed on, as well as his £125,000 'main residence allowance'. In total, this means Mrs Y has a £900,000 tax-free allowance: her allowance, plus her inherited allowance from her deceased husband.

You don't need to do anything to activate this – it's a grim thought but the executors of your will need to send certain documents to HM Revenue & Customs (HMRC) after your death – see HMRC's guidelines.

Quick question

What if my partner died years ago?

What if I'm not married?

While transfers of property and other assets between married couples or civil partners don't attract inheritance tax, this isn't the case for unmarried couples.

If you're not married, but own assets jointly with another person, the situation gets complicated, especially where a residential property is involved. Your liability to pay IHT will depend on whether you and your partner own the property as 'joint tenants' or 'tenants in common' and whether there's a will.

If you're joint tenants (you both own all the property), and your partner's left you everything in the will, then if your partner's assets, including the property, exceed the £450,000 inheritance tax threshold, you'd have to pay it on any assets in the estate above that. After your partner's death, your property would then be owned by you in its entirety.

Even if your partner didn't leave a will, thanks to something called the 'right of survivorship', the property would still go entirely to you although the inheritance tax rules above would still apply.

However, your partner's family would still have a claim to his or her share of other assets such as insurance policies and pension investments.

Quick question

What if we're tenants in common?

Giving a gift? There's no tax to pay if you live a further seven years...

Money given away before you die is still usually counted as part of your estate, hence it's subject to inheritance tax if you die within seven years of giving the gift. Therefore one golden rule is to try to survive more than seven years (vitamin tablets anyone?) – which means early planning of how to pass on your assets is important. Living longer is a good idea anyway!

If you make large lifetime gifts, the beneficiaries could take out life insurance against the potential inheritance tax bill. Most gifts into trust are now subject to inheritance tax even if made during your lifetime, but this is an area where you would need specialist advice.

Other ways to cut your tax bill

However, even if you do die within seven years of making a gift, there are a range of other exemptions worth taking into account to help lessen the tax bill:

You can give £3,000 away each tax year inheritance tax-free

Gifts to charities and political parties are inheritance tax-free

You can give £250 each year to everyone you know

How are gifts from your income treated?

Gifts in consideration of marriage are tax-free

What if I own a farm?

What constitutes a gift?

A gift must be a genuine unconditional gift that you will not gain from; something given to someone without any reservation, no nods, winks or mutual back-scratching. The biggest asset most people have is their house, yet trying to give half of this to your children won't work if you continue to live in it.

Many gifts are a valid ways of reducing your inheritance tax bill. Yet if any (barring the gift on consideration of marriage) are given conditionally, with the intention of receiving something in return, they could fail to work, so watch out.

Should I get financial advice?

Inheritance tax is clearly a huge area of MoneySaving. After all, you don't want to be super-savvy all your life just to have most of what you've saved go to the taxman. If that's what you're worried about, there are a couple of extra things you should think about:

It's crucial to make a will

Get tax advice

Oh and finally, inheritance tax planning is important, but don't forget, the main thing is that you (or your parents) should have financial security in old age. Don't sacrifice everything just to plan for someone else's future. You've earned your money, so let it make you comfortable.

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