Escape the Inheritance Tax Trap
With some careful planning and sensible advice, family wealth can be kept for future generations to enjoy.
There are few more confusing – or unpopular – taxes than Inheritance Tax (IHT). For older generations, the prospect of paying up to 40% tax on what they leave behind is difficult to contemplate. For some children and grandchildren, grappling with IHT is something they are ill-equipped to do.
Yet more and more families are going to have to deal with IHT. The latest figures from HMRC show that the government collected £5.1 billion in IHT in the 12 months to May this year – up 9% on the same period last year1. IHT is set to be even more of a money-spinner for the government in future; the Office for Budget Responsibility predicts that receipts will increase to £6.2 billion by 2020/21.
Many more families are being dragged into paying the tax thanks to soaring house prices, while rising Stamp Duty costs are making elderly people think twice about downsizing. However, there are steps that families can take to mitigate its impact. For Tony Müdd, Divisional Director, Development & Technical Consultancy at St. James’s Place Wealth Management, there are two crucial elements: taking advice and planning.
“The earlier you start thinking about IHT, the easier – and less damaging – it is, and the more options people have,” he says. “That doesn’t mean that, if you leave it late, it’s too late. There are still things you can do; they are just more limited.”
New rules introduced in April this year allow you to pass on more of your estate free of IHT. However, many people are not fully aware of the thresholds, so it’s important to be clear on the facts. The threshold at which your estate becomes potentially liable for IHT at 40% is £325,000 per person. In the 2017/18 tax year, there is an additional £100,000 ‘residence nil rate band’ (RNRB) that can be used against the value of your property – but only if you leave it to a child or grandchild.2 The RNRB is set to rise gradually by £25,000 a year to £175,000 per person from April 2020.
Crucially, the £325,000 threshold and the new RNRB are transferrable, meaning that you can pass both tax-free allowances onto your spouse or civil partner when you die. With the RNRB increasing to £175,000 in 2020/21, a couple could eventually pass £1 million to their children or grandchildren without attracting IHT.
Müdd points to this as an example of “some of the genuinely generous reliefs that have been introduced”. But he adds that the devil often lies in the detail. “When it comes to IHT planning, advice is essential,” he says. “The reliefs often come with caveats and, unless you understand what those are, you are making assumptions. Quite often, those assumptions are wrong.”
For instance, those without children cannot benefit from the RNRB; thus, if you leave your home to a niece or nephew there will be no additional allowance. Likewise, it may not be available when a property has been left in trust, because the beneficiary is a trust, not a direct descendant. It could therefore be important for those who have put such arrangements in place to review their Wills.*
Furthermore, estates valued at £2 million or more will lose £1 of the RNRB for every £2 of value above £2 million; meaning that if your estate is currently worth more than £2.2 million, there will be no RNRB.
Even if you do not consider yourself to be particularly wealthy, you may still find that the value of your individual or combined estates exceeds the tax-free thresholds, so anything that reduces a potential IHT bill is worth considering. Moreover, thoughtful estate planning can help you pass wealth on to your designated beneficiaries in the manner you choose, while reducing your taxable estate.
Five ideas to make life less taxing
There is plenty that can be done to keep a potential IHT bill to a minimum. Here are a few ideas:
- Use the allowance for individuals to give gifts worth up to £3,000 a year (£6,000 if you use the previous year’s allowance as well) without incurring any IHT.
2. Individuals can pass on larger amounts of money free of IHT, so long as they live for seven years after making the gift.
3. Take account of the ‘normal expenditure out of income’ rule – if you give gifts out of your income and, in doing so, don’t damage your standard of living, they are exempt from IHT, and there is no upper limit.
4. Spread your giving over a number of years rather than paying out a lump sum.
5. Don’t give away too much too soon – otherwise you could be dependent on your children.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
*Will writing involves the referral to a service that is separate and distinct to those offered by St. James’s Place. Wills are not regulated by the Financial Conduct Authority.
1 HMRC Tax & Receipts,, 21 June 2017
2 This also applies to other lineal descendants, including step-children, adopted children or foster children.