Tax is one of those unavoidable expenses you have to pay in various forms throughout your life. Sadly, tax bills don’t stop when you pass away because some people’s estates may be liable to inheritance tax.
The following explains more about inheritance tax, how it works, and practical steps you can take with your inheritance tax planning to lower your estate’s liability.
What Is Inheritance Tax?
Inheritance tax, colloquially known as “the death tax,” is a tax on a deceased person’s estate. The tax covers anything of value such as property, money, and possessions or assets.
At the time of writing, inheritance tax gets levied on an estate where the total value of property, money, and assets is £325,000 or more. If inheritance tax applies to your estate when you pass away, the government will levy a 40% tax on anything above £325,000.
According to the Office for Budget Responsibility (OBR), inheritance tax impacted approximately 24,500 estates in the UK for 2015-16 (the latest available data from OBR). That equates to around 4.2% of all deaths for that period.
The OBR also states that they expect inheritance tax “receipts” to increase; they were correct in their expectation, as the latest data trends available (2017-18) show they received £5.2 billion in inheritance tax from people’s estates – up from £4.7 billion in 2015-16.
How Does Inheritance Tax Work?
If a deceased person’s estate value is less than the £325,000 threshold, there is no inheritance tax to pay. However, when the value exceeds the threshold, inheritance tax is liable on anything above the threshold amount.
For example, if your estate’s property, money, and assets come to £750,000, inheritance tax must get paid on £425,000 (i.e., £750,000 minus the £325,000 threshold). Therefore, 40% inheritance tax on £425,000 is £170,000.
It’s possible to pay reduced rates of inheritance tax in some cases. For instance, the estate can pay a lower 36% rate on some assets. But that’s only if a minimum of 10% of the estate gets left to charity.
When you apply for probate (the legal right to deal with a deceased person’s property, money, and assets), you will need to value their estate. It’s a process that can take six months or more, depending on the complexity of their estate.
Note that you don’t need to apply for probate if the deceased didn’t have any assets or only had savings and premium bonds, or had jointly-owned land, property, shares, and money.
Can You Avoid Inheritance Tax?
In most cases, if an estate is worth more than the government’s threshold for inheritance tax, there will be some tax that is payable.
However, there are several practical steps you can take to reduce your estate’s inheritance tax liability when you pass away (more on those steps in the next section). HMRC also offers some “reliefs” from inheritance tax, along with some exemptions:
If the deceased owned a business for at least two years, it’s possible to get partial or complete business relief to reduce its value to calculate inheritance tax liability:
- 100% business relief is available for unlisted companies or other businesses;
- 50% business relief is available if the deceased had controlling shares in a listed company worth more than 50% of its voting rights.
There are also some other ways to qualify for 50% business relief; these relate to land, buildings and machinery.
It’s also possible to gain agricultural relief if the deceased had land or pasture that got used to grow crops or rear animals. However, some assets don’t qualify for agricultural relief, such as farm equipment and machinery, crops, livestock, and unused buildings.
Qualifying items can also get passed onto other people while the person is still living.
Gifts to Certain People or Organisations
If you give cash gifts or assets to your spouse or civil partner while you’re still alive, those items don’t get included when calculating inheritance tax liability. Similarly, such gifts are also exempt from inheritance tax if you leave them to your spouse or civil partner in your will.
Generally speaking, gifts to spouses and civil partners are only exempt if they are UK-domiciled. The exemptions won’t apply to unmarried partners or ones that aren’t in a civil partnership with you.
You can also donate to one or more charities, either in the UK or in qualifying countries in the EU or elsewhere in some cases. Those charitable gifts, either as money or assets, are exempt from inheritance tax.
Charitable organisations can also include local community sports clubs. Lastly, if you would like to make a cash donation to your favourite political party in your will or wish to leave them some other assets, those too are exempt from inheritance tax.
How to Lower Your Estate’s Inheritance Tax Liability
As part of your financial planning for the future, it makes sense to do as much as possible while you’re alive to ensure that your loved ones and those dearest to you don’t have the burden of dealing with inheritance tax.
Thankfully, there are some actionable steps you can take to reduce or even completely eradicate the need for your estate to pay inheritance tax. The following ways will help you to lower your estate’s inheritance tax liability significantly:
1. Use a Financial Adviser
The first step and arguably the most important one is to consider working with a financial adviser. Doing so is a wise way of estate planning because a financial adviser can recommend the best methods for distributing your money and assets when you pass away.
For instance, they might recommend putting some of your money into an ISA or specific investments. Plus, if you have children, your financial adviser may suggest putting some of your money away into a trust for them to access when they become 18 years old.
It makes sense to have such a wealth manager advising you on matters relating to your money and assets, even if you’re unlikely to hit the inheritance tax threshold.
2. Give Away Your Money
One popular method of limiting inheritance tax liability on an estate is to give away as much money as possible while you’re still living. You can technically give individuals up to £3,000 each per tax year as “gifts”; they are known as annual exemptions.
You can also carry forward any unused annual exemptions for each beneficiary – but that’s only possible for one tax year. Other annual exemptions include:
- £1,000 per person for wedding or civil ceremony gifts (or £2,500 for a grandchild, and £5,000 for a child);
- Money to help a child under 18 or an elderly relative with their living costs.
- Unlimited gifts of £250 per person per tax year.
It’s also possible to use more than one annual exemption on the same person, except for £250 gifts.
Note that if you give away more than £325,000 within seven years before you die, and the recipient isn’t a spouse or civil partner that lives in the UK, there will be inheritance tax to pay on those gifts.
The inheritance tax due gets calculated on a “taper relief sliding scale.” For example, if you die within three years of giving away taxable cash gifts, the full 40% tax is payable. At the other end of the scale, if you die in seven years or more of those cash gifts, there is 0% tax payable.
3. Leave Your Money to Charities, Political Parties or Local Sports Clubs
Many people like to leave some or all of their estate to charities, political parties, or local community sports groups. If you decide to leave your entire estate to any of those three groups of beneficiaries, there is no inheritance tax to pay.
Of course, some people decide to leave only some of their estate to those groups and the rest to their loved ones.
In such cases, if more than 10% of the estate gets left to charities, political parties, or local community sports groups, there is only 36% inheritance tax to pay on the portion of the estate left to the deceased’s loved ones.
4. Give Away Your Assets
Another idea to lower your estate’s inheritance tax liability is by gifting assets to other people. In some scenarios, it’s possible to do so and for there to be no inheritance tax payable on those gifts.
For example, suppose you give away certain items like machinery, equipment, furniture, or other tangible assets, and you die seven years or more after those gifts were passed onto their respective beneficiaries. In that case, there is no inheritance tax to pay on them.
However, if you die up to seven years from when you give away your assets, they might be liable for inheritance tax under the taper relief sliding scale mentioned earlier in point two. It’s crucial to discuss giving away assets or money with a financial adviser before doing so.
5. Put Your Assets Into a Trust
Many parents want to leave most or all of their estates to their children. Some people may put assets like money or physical items into a trust so that their children may have them when they reach a certain age (such as 18).
If you survive for at least seven years after making the transfer, the trust is exempt from inheritance tax. But, there are special rules for certain trusts or when the deceased passes away seven years or earlier from the date of transfer.
6. Leave Your Estate to Your Spouse
Are you married or in a civil partnership? If you have no children, or perhaps you are estranged from your children, you could leave your entire estate to your spouse, and it won’t be subject to any inheritance tax – even if it’s worth more than the £325,000 threshold.
What’s more, any unused portion of the deceased’s threshold automatically gets transferred to the surviving spouse or civil partner. For example, if the deceased has an estate worth £200,000, the surviving spouse or civil partner has an extra £125,000 on their threshold.
7. Make Use of Property Allowances
Some parents may decide to pass on property to their children (including adopted children, foster children and stepchildren) or grandchildren for a couple of reasons. Firstly, there is no inheritance tax liable on the property if the deceased’s total estate is less than £2 million.
Secondly, the deceased’s inheritance tax threshold increases to £500,000. It’s possible to pass on a property while you’re still living. However, the seven-year rule will apply.
If you pass on your property to your spouse or civil partner, there’s no inheritance tax liability.
8. Consider an Equity Release Scheme
Some people have all their wealth tied up in properties. As you can imagine, that makes it challenging to leave cash gifts for loved ones while they’re still alive. To get around that problem, they might opt for an equity release scheme.
It’s essentially a lifetime mortgage; they borrow money against their property, and the debt gets paid back from the deceased’s estate or the sale of the property.
9. Take Out Life Insurance Cover
If your estate is likely to attract inheritance tax, you can make life easier by taking out life insurance cover to pay the bill. Life insurance usually is part of an estate for inheritance tax purposes, but it can be exempt if it gets paid out via a trust.
10. Save as Much as Possible In an ISA
Lastly, there’s no denying that saving money in an ISA is a tax-efficient way to gain interest on that cash when you’re living. It’s also an excellent idea to lowering the inheritance tax on your estate when you pass away.
The ISA can get transferred to your spouse or civil partner, exempt from inheritance tax. You can also gift up to £3,000 per child annually into junior ISAs for your children and grandchildren while you’re still alive. Again, they are exempt from inheritance tax.
Speak to an Expert
Do you have questions about inheritance tax? For inheritance tax advice speak to a Bulbfin expert today.