With the inheritance tax (IHT) charge standing at 40% where a person’s wealth exceeds the £325,000 threshold (the ‘nil rate band’), the charge represents a significant issue for many people who own their own house and have other assets. Proper IHT planning is essential if you want to maximise the assets that will pass to your loved ones on your death.
One effective way of reducing the ‘final’ tax bill can be to make a series of gifts from your estate during your lifetime. However, it is important to note that gifts made in the seven years before an individual’s death could still be considered part of the estate for the purposes of IHT. Here we take a look at some key IHT planning points.
The seven year rule
Many gifts made to individuals during an individual’s lifetime will be exempt from IHT as long as the donor survives for seven years after making the gift. However, should this not be the case the gift may affect the calculation of IHT on the estate at death. IHT is charged on an individual’s personal wealth, together with any lifetime gifts that were made in the preceding seven years. While the full rate of tax payable is 40%, it is reduced on a sliding scale for gifts made between three and seven years before the death.
IHT taper relief
Under taper relief, if an individual survives for at least three years after making a gift, the associated IHT will be scaled down on the following basis: Number of years by which gift is survived Taper relief applying
However, it is important to understand that the IHT charge only applies to lifetime gifts where the total value of gifts made during the seven year period exceeds the nil rate band. This is because such gifts are charged before the actual estate at death. So taper relief will not apply unless the gifts made were worth in excess of the nil rate band.
The practical effect of many gifts is therefore to use up some of the nil rate band that would have been available for the estate assets. With this in mind, you may wish to consider taking out an insurance policy to cover the effect of substantial gifts in the event of death occurring within the seven year period.
Some other IHT planning options
- Trusts can allow the transfer of assets out of an estate for the purposes of reducing IHT, while still allowing a degree of control over the assets, with potential IHT charges being 20% on assets over the nil rate band
- Lifetime gifts and gifts on death to a spouse or civil partner are generally IHT exempt, and any proportion of the nil rate band that is unused on the first death can normally increase the nil rate band on the death of the survivor
- Small gifts’ are free of any IHT liability, including regular gifts from surplus income, small annual gifts of up to £250 per recipient, and certain gifts in contemplation of marriage. An annual exemption of £3,000 is also available
- Up to 100% relief may be available on qualifying business assets
- A reduced rate of 36% applies to death estates where 10% or more of the net estate is left to charity.
When considering your IHT plan, it is important to take into account your own financial security as well as your family’s likely future requirements. For a professional review of your IHT planning needs, please contact our expert partner Julie Bloodworth.