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Cutting an inheritance tax bill
Published August 2007
It’s good to give
Consistently rising house prices over previous years have exposed many ordinary homeowners to a potential inheritance tax (IHT) bill as a growing number of estates exceed the current IHT threshold of £300,000 (2007/08).
If you are in a position to gift or give away some of your wealth, this is one of the more straightforward solutions that is worth considering that could reduce a potential tax liability.
The limits on the amounts that you are permitted to give away without affecting IHT have been frozen for more than 25 years, and so the value of these gift allowances has also been severely eroded by inflation. Everyone can give away £3,000 each tax year to anyone they wish. The limit was last raised from £2,000 to £3,000 in 1981. If it had increased in line with the retail price indices (RPI), it would now be worth £8,319.
Husbands and wives each have their own allowance. You don't have to give away the whole amount to one person – it can be divided among a number of people as long as it does not exceed £3,000. This allowance can be carried forward to the next tax year if it is not used.
There are also a number of marriage gifts that have remained unchanged for even longer. They were set in 1975. Parents can give £5,000 (inflation would make it worth £31,383 now) to the bride or groom in the year their offspring is married. Grandparents or great-grandparents can give £2,500 (£15,691) and other family and friends can give £1,000 (£6,277). You can give away unlimited gifts of £250 to any number of people each tax year but you cannot combine this with one of the other gifts that are exempt.
Some gifts can also be made without any cap being set by HM Revenue & Customs. These gifts can be anything of value – for example, shares, antiques or collectibles as well as cash. Provided you survive for a further seven years, the assets are no longer counted as part of your estate and are known as potentially exempt transfers (PETs).
During the seven years, the tax burden gradually decreases. After three years, the tax on the gift is reduced by 20 per cent. Each subsequent year, it falls by a further 20 per cent until it disappears entirely after seven years. So, by the end of the fourth year it is reduced by 40 per cent , then by 60 per cent after five years, 80 per cent the next year and finally 100 per cent after seven years.
One advantage is that the value of a PET is set at the outset, and so any increase in its value during the seven years is disregarded for tax purposes. But, if the gift is in the form of investments or valuables that have increased in value since they were first bought, you could be liable to capital gains tax (CGT) of up to 40 per cent on your profit.
There is another type of gift you can make which avoids all these restrictions. There is no ceiling on the amounts and they immediately fall out of your estate. These are gifts of regular amounts from your income but they are not allowed to reduce your standard of living.
You cannot give away lump sums from your capital. The amounts must come from the income you receive, perhaps from your pension, savings or investments, and they must be surplus to your requirements. The idea is that you are not allowed to impoverish yourself. People often use them to help with their family's mortgage or school fees.
You can give these sums away monthly, annually or as frequently as you wish, and they will not be counted as part of your estate when you die. Gifts to charities, universities and certain national institutions such as museums are also free from IHT.
Everything left to husbands, wives and civil partners is exempt from death duties. Any assets given to other heirs over the £300,000 limit (2007/08) is taxed at 40 per cent.
When to review
It's risky to think of your IHT planning as 'done'. Review your planning (and your will) annually, or immediately you or your spouse's circumstances change, such as:
- You buy or sell a house or flat.
- You get married, or enter into a civil partnership
- There are new children in the family or you become a godparent.
- You change from being employed to self-employed, or vice versa.
- You buy a holiday home, especially if it's overseas.
- There is a substantial windfall, e.g. you inherit a property or win the lottery.
- You divorce, your civil partnership ceases, or you separate.
- You lose a member of the family.
Alternatively, if you own a business or business assets, shares in an unquoted company, or a farm, its value is usually reduced for IHT purposes, provided you meet certain ownership conditions. If you haven’t already, consider investing in these assets – and take advice to make sure you meet the conditions. The reductions include:
100 per cent for your business or your interest in a business (e.g. if you were a partner in a partnership)
100 per cent for your shareholdings in 'qualifying' unquoted companies (including those listed on the Alternative Investment Market).
50 per cent for land, buildings and certain other assets used in a business you were partner of, or by a company you control.
100 per cent for interests in agricultural land, including certain tenancies that started after 31 August 1995.
50 per cent for most other tenanted agricultural land.
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