Inheritance Tax reduces how much of your hard-earned money and property that you can pass on to loved ones. It is therefore natural to want to pay as little as possible!
Everyone has a basic Inheritance Tax allowance called the ‘Nil Rate Band’. This is the amount they can pass on to loved ones on their death, without Inheritance Tax being due. Currently, it is £325,000. Generally, anything that you leave over that amount is subject to Inheritance tax at 40%.
Since the 2017/18 tax year, a new ‘Residence Nil Rate Band’ was introduced. This meant that if you leave the family home, or a share of it, to a ‘direct descendant’, you can get an additional allowance of up to £175,000 (depending on what the home is worth), allowing each person to pass on up to £500,000 to your children tax free.
Gifts in your Will to your spouse or civil partner are not subject to Inheritance Tax. Further, since 2007, married couples and civil partners have been able to transfer any part of their Nil Rate Band allowances that go unused on their death, to the survivor. This includes the new ‘Residence Nil Rate Band’.
In effect this means that a married couple or civil partners can leave their share of the family home to each other first, before it goes to the children. If the couple leave everything to each other, the first-to-die’s Inheritance Tax allowances are completely unused and can be claimed by the second-to-die’s estate. The second-to-die can therefore end up with £1 million of allowances and can in theory leave up to £1 million of assets, with no Inheritance Tax bill.
Married couple Sue and Alan have two children.
Sue dies leaving everything to Alan, then the children.
Sue has not used any of her allowances on death (since gifts to spouses are tax free).
At the time of Alan’s death, the family home is worth £350,000 and other assets are worth £650,000.
Alan’s estate benefits from Sue’s allowances (£325,000 basic Inheritance Tax allowance + £175,000 Residence Nil Rate Band), in addition to his own allowances (£325,000 + £175,000). Everything can be left to the children tax free.
Note that some assets do not use up any of your allowances – for example, most pensions and life insurance policies pass ‘outside of the Will’ and do not fall into the value of your estate for the purpose of calculating Inheritance Tax. You can usually nominate someone who these should pass on to.
Of course, there are rules and cautions. For example, if the total value of all of your assets is £2 million or more, that additional ‘Residence Nil Rate Band’ starts to taper away.
Another point is that if you have minor children and you want to leave money in a trust, it has to be the right kind of trust to ensure some of those allowances (the ‘Residence Nil Rate Band’ in particular) are available. You can find out more about trusts for minor children here.
Finally, it is rarely advisable to leave ‘everything to each other, then the children’. This type of Will can see your children disinherited completely. Instead, you might leave your spouse or civil partner use of your share of the assets for life, after which your children inherit either directly or through the right type of trust. All Inheritance Tax allowances will still be available in such a scenario.
If your assets also include business or agricultural property, these should be evaluated to see if Business or Agricultural Property relief is available. This can potentially reduce the Inheritance Tax payable on either type of asset to 0%.
If you include a gift to charity in your Will, it may reduce the amount of Inheritance Tax that is payable. To qualify, the gift must equal 10% of your ‘net estate’. This reduces the Inheritance Tax rate down from 40% to 36%.
Tax planning for larger estates
For those who already have assets worth more than the £1 million allowances available, it is important to give some consideration to tax planning alongside making the Will.
For those who do not, remember that the tax is based on the value of the assets at your death rather than the value of the assets right now. House values in the UK have risen by 60.26% over the past ten years. The average UK house price was £281,000 in April 2022 – £31,000 higher than the same time the previous year. Using these figures and your life expectancy, are you still confident your estate won’t pay any Inheritance Tax when you die?
Of course, this doesn’t mean you should immediately start gifting away your property – but it is something you need to consider while you are in good mental health and have the capacity to take action – especially if you are anywhere near the threshold.
Lifetime gifting may be one way to reduce the value of the estate before death. There are many lifetime gifting allowances that have no consequence for Inheritance Tax. Even for gifts that come over those allowances, they can still have no consequence for Inheritance Tax if you survive for 7 years after making them.
Lifetime gifts do not have to be made directly – in some cases, they can be made into trust, or into a special type of company. However, careful thought needs to be given as to whether you will have enough assets left for yourself, together with any income and Capital Gains tax implications. You should also be cautious about gifting business or agricultural property, checking carefully the Inheritance and Capital Gains tax position of gifting this during your lifetime in comparison to leaving it in your Will.
Tax planning for unmarried partners
Unmarried partners are treated far less favourably than those who are married or in a civil partnership.
First and foremost, if one partner dies without making a Will and the assets are not in joint names, the survivor will inherit nothing. Under Intestacy Rules, the deceased’s children will be first in line to inherit. The survivor could make a claim under the Inheritance Act but the success of this claim is by no means a certainty.
Unmarried couples have the same £325,000 Nil Rate Band and the same Residence Nil Rate Band of up to £175,000. However, gifts to each other in their Will are not tax free, and they cannot transfer unused allowances.
Unmarried couple Georgia and Sam have two children.
They own a property in equal shares and each have savings.
Georgia dies leaving her share of everything to Sam. As they are not married or in a civil partnership, this gift is NOT tax free. Further, although her allowances are not fully used, the unused portion is lost. Sam’s estate will therefore only benefit from his allowances totalling £500,000.
At the time of Sam’s death, the property is worth £350,000 and the total savings are worth £250,000.
This exceeds Sam’s allowances by £100,000. Inheritance tax at 40% (£40,000) will be due.
Since unused allowances cannot be shared, it is important for unmarried couples to consider ‘who owns what’ and whether assets could be shared out more evenly between them. If one person owns everything and is the first to die leaving everything to the other, there are two huge potential problems:
- A large inheritance tax bill on the 1st death which could be particularly difficult to pay if most of the value of the estate is tied up in the family home.
- Another large inheritance tax bill on the 2nd death. This is less problematic as the family home can simply be sold but at the same time, it does reduce the value that can be passed on to children/grandchildren.
For larger estates, unmarried couples may wish to take out life insurance to cover the tax. You could also consider leaving assets directly to the children on the first death, if they will not be needed by the survivor.
Law for you and your family.