Inheritance Tax (IHT) can be a sensitive topic due to the nature of the circumstances surrounding it. Due to it often not being discussed until the last minute, there is a lack of knowledge about Inheritance Tax.
It is often said that IHT is voluntary because there may be different steps you can take to reduce the amount that HMRC can claim. To plan effectively for IHT, you need to understand it and what it means for your estate. As with any tax planning, it is always best to discuss your options with an accountant early. This can enable you to choose what is right for your personal situation, and time your actions to reduce your tax bill as much as possible.
It is very important that you leave a Will. Without one, your estate may not be distributed in line with your wishes, as the courts will decide how it is divided and therefore it is very unlikely to be in the most tax-efficient manner. Worst case scenario (if you die without blood relatives), your estate could end up entirely with the Crown. Even if this doesn’t happen, your estate may end up with relatives you are not in touch with or, depending upon the order of death where spouses or partners dies close together, with only one side of the family. You should also bear in mind that the law on the succession of your estate does not take into account unmarried partners (unless they are in a civil partnership) nor people to whom you are not related (no matter how long-established the friendship). It’s true that, where there is an element of dependency, there may be the possibility of a claim for fair and reasonable financial provision , but this certainly won’t come tax-free or even tax-efficient.
Make sure you review and update your Will after any major life events (buying a new house, having children, grandchildren, etc) so that it always accurately reflects your current wishes, rather than your wishes at the time of initially writing it, because you may have changed your mind, or circumstances may have changed.
IHT is a tax on the estate (the property, money, and possessions) of someone who has died. It relates to all the assets that they own at the time of their death, no matter where these assets are situated. The value on which the tax is assessed may also include lifetime transfers (which are covered below).
The standard rate of IHT is 40%, and it is only applicable to the value of your estate that is above the threshold known as the Nil Rate Band. Currently £325,000 per individual, it has remained at this level for over ten years and is unlikely to be increased in the near future. It’s important to understand that lifetime transfers may erode your Nil Rate Band.
If you leave at least 10% of your estate to a charity, then that bequest is tax-free and the rest of your taxable estate will be taxed at 36% not 40%.
There is normally no IHT to pay if either:
- the value of your estate is below the Nil Rate Band (£325,000) and the Residence Nil Rate Bank (see below)
- you leave any excess above the Nil Rate Bands to your spouse, civil partner, a charity, a political party with at least one MP or for public or national benefit
Even if the value of your estate is below the threshold, you will still need to report it to HMRC.
Residence Nil Rate Band
This further zero-rated band has been available since tax year 2017/18 for transfers on death only (not life-time transfers). If you leave a property in which you have lived as your main residence to your children (including adopted, foster or stepchildren) or grandchildren (‘lineal descendants’) then a further tax-free allowance applies. This does not have to be the home you last lived in but you must have occupied it at some point. The rules also apply to interests in properties that are less than the whole property, such as a percentage share or a lease carved out of the freehold.
The level of the Residence Nil Rate Band increased year by year to £175,000 in tax year 2020/21 and will then increase in line with the Consumer Prices Index for the year. However if your total estate is worth more than £2 million then your RNRB will be cut by £1 for every £2 excess over £2 million.
For a property to attract this relief, the qualifying beneficiaries must be able to inherit on your death, so for example if it were held in trust until children or grandchildren reach a given age, then this relief would be lost. In general terms you must still own the property when you die, but ‘downsizing relief’ may be available to preserve the RNRB, provided that the proceeds of sale are still identifiable.
Despite the restrictions, it’s worth arranging your affairs to take advantage of this potentially valuable relief as it can increase the ‘nil-rated’ proportion of your estate to in excess of £500,000 for an individual.
Update: expected changes in the Law.
We need to keep a look out for the new Bill currently making its way through the House of Lords.
In most cases, an exemption from IHT is available on assets that are passed on death to a surviving spouse or civil partner. Unlike some countries, there is no similar provisions in the UK for exempt transfers between siblings, who have lived together for many years. A new Bill that would amend the existing rules and provide relief for siblings under specific scenarios is currently making its way through the House of Lords.
This Bill, upon receiving Royal Assent, will allow a surviving sibling to benefit from an IHT exemption. The surviving sibling would need to be over the age of 30 and have lived with their sibling for more than 7 years before the date of death. For the purposes of this Bill, siblings are defined as sisters, brothers, half-sisters and half-brothers.
These changes, whilst not having an impact on many people, will offer significant benefits for those that do qualify and could help elderly surviving siblings stay in homes that they have lived in for many years. Until these changes become law, there are certain estate planning actions that should be explored if you are in a similar position.
IHT is a complex area, and it is vital that it reflects your requirements taking into account the legal implications. If you would like to talk to us about your specific situation, please contact.