Inheritance tax was always viewed as a death duty that only affected the seriously wealthy. But with the boom of property prices in the last decade, more and more ordinary families are being hit with paying inheritance tax of 40 per cent on any assets they inherit from their loved ones.
The number of properties that have been valued over the inheritance tax threshold has almost doubled in the past five years, and the average detached house in London, the South East and the South West is already worth more than £300,000. Because of this, even those who are short of cash or other assets, but have a home worth more than the inheritance tax limit, are struggling as they cannot dispose of their home to bring their wealth underneath the inheritance tax threshold.
If you’re alarmed at the tax bill you’ll have to pay when you inherit from you parents and are also concerned about the amount of inheritance tax your heirs will have to pay, you can get specialist inheritance tax advice. But here’s our guide, from the experts, on how you can take action immediately to save inheritance tax.
1. Use the inheritance tax nil-rate band.
We can all leave up to £325,000 to friends or family free of inheritance tax, but sums above this are taxed at 40 per cent. This exemption allowance, called the ‘nil-rate band’, only relates to the amount of money you leave to your heirs; assets that are passed between spouses (or civil registered partners) are free of inheritance tax, regardless of what they are worth.
As of October 2007, Alistair Darling has announced that married couples, and civil registered partners, can now inherit each other’s unused element of the nil-rate band when one of the couple dies, giving them a joint nil-rate band of £650,000 (which will increase to £700,000 in 2010-2011).
This means that they will be able to transfer their unused individual allowance to the surviving spouse. So when the first spouse dies, their share of the home and any other assets can be transferred simply to the spouse who is still alive. But when the second spouse dies, and if the first spouse didn’t use their entire nil-rate band on death, inheritance tax will only be paid if the assets exceed the £650,000 threshold.
Unfortunately, this doesn’t apply if you’re living with your partner but you’re not married, or if you’re single. If you cohabit, you can both use your individual allowances of £325,000 (rising to £350,000 in 2010-11) and still be able to pass on £650,000 inheritance tax-free to your children. But you cannot leave assets which are worth more than £325,000 to each other without facing an inheritance tax bill. This could cause problems if one of you dies.
2. Make a will or check that your existing will is up to date.
If you don’t have a will, you will die ‘intestate’ and the State decides who will inherit your money and assets. The rules in England & Wales are complex, but broadly speaking the bulk of your estate will go to your spouse (including a registered civil partner) or, if none, to your children (whether or not they are adults) and, if none, to other blood relatives.
The effect of the intestacy rules depends partly on the size of your estate. If your estate is large (currently more than £250,000 where there are children – even if they are adults – and £450,000 where there are none), less than you expect may go to your spouse. So it’s always prudent to have a valid Will rather than rely on the intestacy rules.
By making a will you could, for example, transfer some of your assets to children, grandchildren or others after your death within the nil-rate band, which would mean that these bequests were free of inheritance tax.
Note that it’s important that you revise your will whenever your circumstances change; for example, when there is an addition to the family, your spouse dies or a divorce occurs.
Find out more about the rules of intestacy here.
Find out more about making a will when your circumstances change here.
If your affairs are straightforward, find out how you can write a Will now.
3. Give your property away.
To save inheritance tax, you can use the following annual exemptions:
- You can give away up to £3,000 in each tax year, without being liable for inheritance tax, and the unused portion of the previous year’s exemption can be carried forward. So couples who haven’t made use of their allowances last year can give away £12,000 in total this year. But it can only be carried forward for one year.
- You can also give away £250 to any one person if the total gifts to that person don’t exceed £250. This exemption can be used to cover Christmas and birthday gifts from grandparents to grandchildren.
- Wedding gifts are also exempt. Each parent can give to each child £5,000. A grandparent can give each grandchild £2,500 and anybody else can give the newlywed £1,000. But you must make the gift shortly before the marriage, as it only becomes exempt from inheritance tax when the marriage takes place.So, if your daughter, for example, is getting married and you, and your spouse, want to give her money for a deposit on a house, you could give her £22,000 in one year. You can use both your allowances this year (£6,000) plus last year’s (£6,000) plus two wedding gifts of £5,000 each.
4. Give away any surplus income.
If you have surplus income year on year, then you can give it away free of inheritance tax. But you need to be able to show that these gifts are part of your regular annual expenditure and that they don’t reduce your standard of living. You can also use this exemption to pay life insurance premiums for the benefit of someone else.
It’s advisable that you keep a record of these gifts and, if possible, a record of your net (after tax) income. This exemption can be very useful as there is no upper limit, so it’s worth keeping the documentation.
5. Think of a potentially exempt transfer (PET)
Before you die you can give assets, cash or property away, but you have to survive for seven years after you have transferred them before they are free of inheritance tax.
After a period of three years, your beneficiary may get some tax relief and this can increase each year until the seven years has expired. But if the gift is worth less than the nil-rate band, the whole amount is added back into your estate when the taxman is calculating your inheritance tax liability.
You cannot get out of paying inheritance tax if you give away your home but continue to live in it rent free, as, under these circumstances, the taxman still considers it to be part of your estate. But you can give your home away to your child if they live with you, as long as they live in the property until you die or you go into a care home, and both of you must contribute to the running costs of the property.
6. Get business property relief.
Certain categories of business and business assets may qualify for 100 per cent exemption from inheritance tax after two years. The relief normally applies to a business or an interest in a business (partnership) or to shares in an unlisted company. Shares quoted on the Alternative Investment Market also qualify after you have held them for two years.
If you think that you qualify for such a relief, then it’s best to obtain professional advice.
7. Donate to charity.
Gifts to charities, political parties (providing that they have at least one MP and 150,000 votes), registered housing associations and gifts for national purposes are also exempt.