Inheritance Tax (IHT) Planning

IHT is charged on a person's estate when they die and on certain gifts made during their lifetime.

The rate of tax on death is 40% and 20% on lifetime chargeable transfers. The first £325,000 is not chargeable. This exemption is known as the nil rate band.

Most gifts made more than seven years before death will escape tax. Therefore, if you plan in advance, gifts can be made tax-free. The result can be a substantial tax saving.

We give guidance below on some of the main opportunities for minimising the impact of the tax.

Estate Planning
Much estate planning involves making lifetime gifts of capital to use exemptions and reliefs or to benefit from a lower rate of tax on lifetime transfers.

Any plan must take account of your circumstances and aspirations. The need to ensure your financial security (and that of your family) cannot be ignored. If you propose to make gifts, the interaction of IHT with other taxes needs to be considered carefully.

If you do nothing you may become exposed to a large IHT liability.

Wills
As the main IHT liability is likely to arise on death, a sensible and up to date Will is important.

Using the Nil Rate Band
On death, it is vital to ensure that the nil rate band, currently £325,000, is used, assuming that it has not already been utilised over the last seven years. Transfers between spouses are exempt from IHT.

Example: John dies leaving the whole of his estate of £800,000 to his wife Jane. A few years later Jane dies, leaving her whole estate of £900,000 to her children.

On John's death there is no IHT due, as transfers between husband and wife are exempt. However, on Jane's death the nil rate band not used on John's death will be available against Jane's estate, as well as her own nil rate band. The IHT payable will be based on £250,000 (£900,000 less the current nil rate band of £325,000 x 2).

Whilst the new rules certainly help, further careful planning could eliminate this bill entirely.

Another nil rate band An additional nil rate band of £100,000 is introduced where a residence is passed on death to direct descendants, such as a child or a grandchild. The additional band can only be used in respect of one residential property which has, at some point, been a residence of the deceased. The amount is gradually increasing over the next few years reaching £175,000 from the 2020/21 tax year. 

Any unused nil rate band may be transferred to a surviving spouse or civil partner in a similar way as above. It will also be available when a person downsizes or ceases to own a home on or after 8 July 2015 and assets of an equivalent value, up to the value of the additional nil rate band, are passed on death to direct descendants.

There is a tapered withdrawal of the additional nil rate band for estates with a net value (after deducting any liabilities but before reliefs and exemptions) of more than £2m. This is at a withdrawal rate of £1 for every £2 over this threshold.

Exemptions
There are many valuable IHT exemptions. The main ones follow. Ensure you're making full use of them!

Annual exemption £3,000 per tax year may be given by an individual without an IHT charge. An annual exemption may be carried forward to the next year but not thereafter.

Small gifts Gifts to individuals not exceeding £250 in total per tax year per recipient are exempt.

Normal expenditure out of income Gifts made out of income which are typical and habitual and do not result in a fall in the standard of living of the donor are exempt eg the payment of annual premiums on life insurance policies would usually fall within this exemption.

Family maintenance A gift for family maintenance does not give rise to an IHT charge. This may include the transfer of property made on divorce under a court order, gifts for the education of children or maintenance of a dependent relative.

Wedding presents Gifts in consideration of marriage are exempt up to £5,000 if made by a parent, with lower limits for other donors.

Gifts to charities Gifts to registered charities are exempt provided that the gift becomes the property of the charity or is held for charitable purposes.

Reliefs
When business or agricultural property is transferred there is a percentage reduction in the value of the transfer. Often this provides 100% relief. In cases where full relief is available there is little incentive, from a tax point of view, to make lifetime transfers of such assets. Additionally, no CGT will be payable where the asset is included in the estate on death.

However, the reliefs may not be so generous in the future and therefore gifts now may be advisable. What will happen to any business or agricultural property included in your estate on death? Leaving it to your spouse can waste any available relief. Consider leaving such property to someone else.

Life Assurance
Life assurance arrangements can be used as a means of removing value from an estate and also as a method of funding IHT liabilities.

A policy can also be arranged to cover IHT due on death. It is particularly useful in providing funds to meet an IHT liability where the assets are not easily realised, eg family company shares.