JSP Financial Services Limited

May 2024 

Inheritance Tax Questions and Answers

HMRC collected about £7.6 billion in Inheritance Tax in the last tax year, and this figure is expected to rise to about £10 billion over the next 5 years.

It is a tax that is particularly disliked – “why should tax be levied on my death if I’ve been careful and saved, paid plenty of tax in my lifetime, and just want to pass my savings to my children?” It is also a complicated tax to understand and to try to reduce, so I attempt to explain some of the main points.

What Are “Nil Rate Bands”?

These are simply the major allowances which are tax free. The first £325,000 of someone’s estate on death is usually tax-free (known as the Nil Rate Band). On top of this, there is an extra allowance (the Residence Nil Rate Band) of up to £175,000 where your estate includes the family home as long as the home is worth at least that amount, and is passed on death to direct beneficiaries (children/grandchildren) and your estate is worth less that £2 million.

This could mean that up to £500,000 is available before any Inheritance Tax is payable on death.

If you do not own your home then your allowance is only the £325,000 Nil Rate Band.

I’m married – How Does This Affect Allowances?

Anything that is left to a spouse or civil partner is Inheritance Tax free at that point, and a surviving spouse can also inherit the deceased’s unused Nil Rate Bands described above.

This could mean that up to £1,000,000 (£1 million) is available before any Inheritance Tax is payable on the second death.

We Co-Habit. Are We Treated The Same As Married Couples/Civil Partners?

No.

Each of your will have your own Nil Rate Band allowances, but they cannot be inherited by the survivor on first death.

I’ve Heard That I Can Give Away Only £3,000 A Year To Try To Reduce My Estate. Is That Right?

No.

You can give away any amount you want – at the moment it’s your money and you can do what you like with it, without any immediate Inheritance Tax Charge usually.

I say above “at the moment” as some people on the left side of politics have suggested that there should even be a limit to the amount that can be given away in your lifetime without paying immediate tax.

The amount of any gift you make however remains in your estate for Inheritance Tax purposes for 7 years, so if you die within 7 years the gift will still be treated as part of your estate.

So, let’s say you are cash rich and give away £225,000 to your children. If you survive for 7 years, then the gift falls outside of your estate when calculating any Inheritance Tax payable on your death. If however you die within 7 years then the value of the gift will reduce your Nil Rate Band allowance from £325,000 to £100,000.

But If I Give A Gift Now, I Understand That Its Value Is Reduced For Inheritance Tax If I Die Within 7 Years?

No. This rule is often misunderstood.

This revolves around the so-called “taper relief” under which the gift is reduced in value for Inheritance Tax purposes if you die after 3 years of making the gift by 20% in the fourth year and then by 20% each year after.

The rule applies only to gifts in excess of the Nil Rate Band of £325,000. The amount of the gift reduces your Nil Rate Band allowance for the full 7 years, and becomes fully exempt only after 7 years. So, as above if you make a gift of £225,000 and die within 7 years, then the only effect is that your Nil Rate Band allowance on death is reduced to £100,000. If however you make a gift of £425,000 and die within 7 years, the £100,000 is “tapered” so that only 80% is taxable in year 4, 60% in year 5, 40% in year 6 and 20% in year 7.

What Is The £3,000 Figure Then?

The £3,000 mentioned, as well as certain other gifts, is fully exempt from Inheritance Tax.

These main exemptions are:-

• £3,000 per tax year that you can split between people.

• £250 per tax year that you can give to other people (as many as you like).

• £5,000 to your children on getting married (£2,500 if grandchild getting married).

• Unlimited gifts from your surplus income. These must be regular, not affect your standard of living, and must be from natural income and not capital, so detailed records would be required.

There are certain other exemptions relating to business and agricultural property, although these are outside of the scope of this newsletter.

Can I Give Away Shares Or Other Investments?

Of course, but unless gifting to your spouse then the gains on the investments would be subject to Capital Gains Tax at the time of the gift, payable by yourself.

Will Charitable Gifts In My Lifetime Reduce My Inheritance Tax Bill?

Yes/No. They do fall outside of your estate immediately but cannot reduce the Inheritance Tax payable on your estate on death.

If however you gift on death at least 10% of your estate to charitable causes then the Inheritance Tax rate on the balance of your estate is reduced from 40% to 36%.

What Counts As My Estate On Death?

Practically everything.

Your house

Any other properties

Your savings and investments, including ISAs

Your home contents

Jewellery

Cars

Etc

Does My Pension Fund Count As Part Of My Estate?

No (as long as the funds are distributed to your beneficiaries with 2 years of death).

So, a married couple with a total estate of £1 million (including the family home worth at least £350,000) and pension funds worth £1 million would not face Inheritance Tax at all.

This does not mean that the beneficiaries can receive your pension fund on your death entirely tax free – there are limits if you die before age 75, and will certainly be subject to income tax if you die after age 75.

Can I Gift My Pension Fund On Death To My Spouse Or Children?

Yes.

The funds would be largely tax free (up to certain limits) if you die before age 75.

If you die after 75 then there is no Inheritance Tax but the beneficiaries may face income tax when they access the funds.

Again, there is speculation that this could change under a new government.

Can I Gift My House To My Children/Grandchildren Whilst I’m Alive For It To Fall Outside Of My Estate On Death?

Yes technically, but No usually.

It only works for Inheritance Tax purposes if you pay the full market rent to the children for continuing to live in it. If not, it is included in your estate. HMRC clawed back about £600 million over the last 5 years from families who were in breach of this “gift with reservation” benefit.

Even if you decide to pay a commercial rent, there are certain other disadvantages in giving away your property whilst alive. Your beneficiaries own it, which could affect the position if they get divorced or become bankrupt for example.

I’ve Heard That Trusts Can Solve All Of These Problems?

No.

Trusts are a great way to pass wealth down tax efficiently but care is needed as they are complicated.

A “Bare Trust” is the simplest form involving named beneficiaries normally children, but income and gains from investments held by the trust are taxable on the children (who will have their own personal allowances) and they have the right to get hold of the money at age 18, which may not be your intention.

A “Discretionary Trust” gives you more control, but gifts of assets in excess of £325,000 are subject to an immediate Inheritance Tax charge of 20%. In addition, annual tax returns will usually be required and there are periodic charges on the value of the trust in excess of the Nil Rate Band of 6% usually every 10 years or where money comes out of the Trust.

If a Discretionary Trust is created in a Will, there is no Inheritance Tax saving but there are no further charge on the assets included in the Trust.

Trusts are a complicated area and you should seek professional advice.

Are There Any Other Exemptions?

There are certain reliefs for business property or for shares held that are listed on the Alternative Investment Market (AIM). Many such shares qualify for relief once held for 2 years (and which are still held on death), but not all shares qualify and HMRC does not publish a list of those that do. These are generally high risk and illiquid investments and you should not invest simply for tax purposes – it could cost you more than the 40% Inheritance Tax saving.

What Should I Consider?

Inheritance Tax cannot be considered in isolation.

Taking action to try to reduce any potential Inheritance Tax liability can often cause problems later – you have to have sufficient income and savings to live now, and the main problem is that we do not know how long we are likely to live. For most people, even a relatively short stay in a nursing home will take care of their Inheritance Tax concerns by reducing the value of their assets.

It all requires very careful consideration.

You should note that the above is a very brief consideration of Inheritance Tax and there are many complexities. You should not rely on these notes for your planning.

Further Details? Request our:-

• Our Guide To Inheritance Tax
• Inheritance Tax And The Family Home
• Long Term Care And The Family Home

Contact John Perry should you wish to discuss any aspect covered in this Newsletter