When thinking about what you want to leave to your children after you die, it’s important to consider the impact of Inheritance Tax. Making plans today could mean that your children inherit more and lose less in tax.
What is Inheritance Tax?
Inheritance tax is a tax on the estate of someone who has died, including all property, possessions and money. For Inheritance Tax purposes, the estate value which is subject to tax also includes any gifts made in the 7 years prior to death.
Inheritance Tax may also be due on certain transfers made during a person’s lifetime and depending on the type and value of a trust, there may be ongoing tax charges during the lifetime of the trust.
The rate of Inheritance Tax is 40% and is charged on the part of your estate that exceeds the Inheritance Tax limit, subject to available exemptions and reliefs.
Who pays the inheritance tax when you die?
Funds from your estate are used to pay Inheritance Tax to HM Revenue and Customs (HMRC). This is done by the person responsible for administering the estate called the ‘executor’ and must be paid by the end of the sixth month after the person died. If the assets in the estate take time to sell (for example a property) then it may be possible to pay Inheritance Tax in annual instalments over 10 years with added interest.
Your beneficiaries (the people who inherit your estate) do not normally pay tax on things they inherit as the tax is deducted before any distributions are made. However, if you have given a large gift to someone in your lifetime and you die in the following 7 years, the recipient might have to pay Inheritance Tax on the gift.
What is the inheritance tax limit?
Your estate will need to pay inheritance tax when it’s value is above the Nil Rate Band of £325,000. If your estate (including any gifts made within the last 7 years) is below this threshold, your estate will not pay any Inheritance Tax.
The NRB has been frozen since April 2009 and will remain fixed at £325,000 until 2026 (subject to future reviews).
Leaving property to your children
There is an extra allowance that was introduced for deaths that occur on or after 6 April 2017, called the Residence Nil Rate Band, which means your estate could benefit from up to £175,000 (20/21) tax-free.
Unlike the Nil Rate Band, this allowance comes with qualifying conditions. Under the rules, the allowance only applies if you leave your home to a direct descendant – which means a child or grandchild or other lineal descendant (also includes a husband, wife or civil partner of a lineal descendant, a child who is, or was at any time, their step-child, their adopted child, a child fostered at any time by them or a child where they’re appointed as a guardian or special guardian when the child is under 18).
Not everyone qualifies for the full allowance, especially if your total estate is worth more than £2 million. For every £2 that the estate exceeds the £2m taper threshold, the Residence Nil Rate Band will reduce by £1.The value of the estate for these purposes is the total of all the assets in the estate less any debts or liabilities before any exemptions and reliefs are applied.
If the value of your share in the home is less than the maximum Residence Nil Rate Band, then the allowance applied will be capped at the value of the share. Even if you have sold your property before you die, it may still be possible to claim the allowance (known as a downsizing addition) subject to qualifying criteria.
Married couples and civil partners
There is no Inheritance Tax on transfers between married couples and civil partners. Provided the whole estate passes to the surviving partner on first death, the unused tax-free allowances (both the NRB and the RNRB) can pass to the surviving spouse or civil partner, essentially doubling both allowances (if applicable) and providing up to a maximum of £1,000,000 free of tax to claim on second death.
There is a restriction that if the recipient spouse is not UK domiciled, then the exemption is limited to £325,000. Domicile is a legal concept which considers an individual’s long term home. This is a complex area of law, particularly for inheritance tax purposes and requires professional advice.
There are some other exemptions and reliefs for Inheritance Tax which you can find here
Why you should seek advice on Inheritance Tax Planning
There is a lot for your family to gain from you spending time looking at what their inheritance might look like, and how to pass gifts to them tax-efficiently.
The more you plan ahead, the easier it will be for your loved ones in dealing with the estate after you have gone.
But tax planning can be complex, and there are many rules and requirements in setting up trusts, making gifts and other inheritance options. By seeking expert advice you can explore the best ways to look after your dependents, pay the tax that’s owed and keep things simple for everyone.
We help people explore their options and make sense of this complicated area. For an initial, free phone consultation, contact us today.
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