How to Save Inheritance Tax

When someone passes away in England and Wales, there may be Inheritance Tax to pay. Inheritance Tax is usually paid out of the Estate as a debt before anything is distributed to a beneficiary. The responsibility to pay Inheritance Tax belongs to the Executors, not the beneficiaries.

What is Inheritance Tax?

Inheritance Tax is a tax levied on property and money acquired by gift or inheritance and it was introduced originally in 1986. When Inheritance Tax is payable, the rate is 40% as standard. However, there is a tax-free amount, similar to income tax, that applies before any tax becomes payable. The current tax-free allowance is £325,000.

So, for example, the value of your estate is £400,000 and your tax-free threshold is £325,000. The inheritance tax charged will be 40% of £75,000 (£400,000 minus £325,000). The standard rate of 40% drops down to 36% when estate leaves more than 10% of its value to charity. If your main residence is being transferred to direct descendants, such as children after you have passed away, you could be eligibly for an additional £175,000 tax-free allowance. This means your total allowance would be £500,000 before the 40% rate of tax is applied.

If you are married, leaving everything to your Spouse or Civil Partner, your estate benefits from Spousal Exemption. This is where everything passing to a surviving spouse or civil partner is tax-free and does not use your tax-free allowances. This means that, once you have both passed away, the Estate will benefit from both sets of tax-free allowances. So, for example, if you are married or in a civil partnership leaving everything to your spouse or civil partner, everything you leave to them is tax-free. They also inherit your unused tax allowances of £325,000 and £175,000. When your spouse or civil partner passes away, as long as they have not re-married, their estate will have a tax-free allowance of up to £1,000,000.

There are various other strategies to reducing your estate. One such method is placing assets within a trust (that meets certain conditions), so they don’t form part of your estate and could save money when you die. Trusts can be an effective way of lowering Inheritance Tax, but expert guidance should always be sought prior to setting one up. Trustees are accountable for purchasing, selling and investing the trust assets responsibly – records should also be kept of all gifts made since HMRC may require these to determine how much Inheritance Tax must be payable after your death.

Another effective strategy for lowering your Inheritance Tax liability would be to use your annual gifting allowances. For more advice on this subject, speak with one of senior advisors to get additional insights. We can help quantify potential IHT taxes while outlining steps you need to take in order to minimise them. Other tax reliefs such as Business Relief and Agricultural Relief allow some assets to be passed on without incurring any Inheritance Tax or with a reduced bill.

Which Assets are within your Estate?

At first, it’s important to ensure you have an accurate overview of all assets within your estate. If necessary, seeking professional guidance (an inheritance tax adviser or financial planner) could assist. If your estate is complex enough, these professionals may also help provide support in this aspect of planning. This may involve calculating the total value of your estate for probate and administration and affect the tax liability on other assets. It is important to seek professional advice to understand the implications related to these assets.

Some assets are not part of your Estate for Inheritance Tax purposes. These can include certain Life Insurance policies and pension funds and assets held in a trust.

Some individuals choose to give away money or property during their lifetime in order to reduce the size of their estate and potentially cut inheritance tax bills, usually by setting up a trust. A trust is a legal arrangement in which money or property is transferred to someone else for care for a third-party beneficiary (your beneficiary), with you setting rules regarding when and how beneficiaries may access these funds.

The 7-year rule

Gifting property into trusts or giving assets away outside of your gifting allowances will have the effect of exempting it from IHT if you survive seven years after giving it, making it a “Potentially Exempt Transfer (PET)”. However, if you were to pass away before the 7 years has passed, this gift or transfer can still be subject to IHT, but at a lesser rate.

It is important to note, that the 7-year rule does not apply to a gift you have given that you still receive a benefit from. This is known as a Gift with Reservation Of Benefit (GROB). These types of gifts could be a gift of property where you continue to live free of charge. This gift would still be classed as part of your estate for IHT purposes.

When does Inheritance Tax have to be paid?

Inheritance Tax typically needs to be paid within six months from the end of the month in which the deceased passed away. This payment deadline applies to the tax on the estate and any related tax on gifts made within the 7 years before death. It is important to understand and address the payment obligations to avoid penalties and interest. Arrangements can be made with HMRC to pay the IHT bill over a period of time but interest will be added to this and the Estate cannot be finalised until the IHT has been paid.