Inheritance tax (IHT) in the UK no longer applies only to the wealthiest individuals. Thanks to rising property prices over the last two decades, many people will now face IHT upon passing their estate to their loved ones. It’s concerning to think that a significant portion of your wealth may be lost to tax rather than benefiting your family. Understanding the rules and knowing how to reduce your liability is crucial for effective estate planning.
The Inheritance Tax Threshold
Generally, no inheritance tax is due if an individual’s estate is valued at £325,000 or less. This is known as the ‘nil rate band.’ If the estate exceeds this threshold, the excess amount is taxed at 40%. However, there are several exceptions that can affect the rate of tax applied.
Key Exemptions for Married Couples and Charitable Donations
If you leave your estate to your spouse, civil partner, or a charity, no inheritance tax will be charged. This allows you to pass an unlimited amount of wealth to your spouse without triggering IHT.
Additionally, if the first partner in a marriage or civil partnership passes away, any unused portion of the £325,000 nil rate band can be transferred to the surviving partner. However, the total inherited nil rate band will not continue to grow if the surviving spouse is widowed again.
For those interested in charitable giving, there is an advantage: if at least 10% of your estate is left to charity, the standard 40% IHT rate is reduced to 36%. This can help reduce your IHT burden while supporting causes you care about.
Inheritance Tax on Property
In 2017, the government introduced the ‘residence nil rate band,’ a valuable benefit for homeowners. This allows an additional £175,000 to be added to your £325,000 nil rate band when passing property on to direct descendants, such as children. The property must have been the deceased’s main residence, and only one property can benefit from this allowance.
For married couples or civil partners who own a property, this effectively allows £1 million in assets to be passed on to their children without incurring IHT. However, this benefit starts to decrease for estates worth over £2 million. In such cases, it’s advisable to seek professional guidance to ensure you’re maximizing your potential allowances.
Strategies for Reducing Inheritance Tax Liability
One effective method for reducing IHT is through gifting. Each individual can gift up to £3,000 per year without incurring IHT. Additionally, you can make gifts from your excess income, provided you can demonstrate that the gift is made from income you do not need to meet your living expenses. These gifts are not subject to tax, offering a way to reduce your estate size without triggering IHT.
Gifts made more than seven years before your death are also excluded from your estate for IHT purposes. However, gifts to trusts are subject to different rules, so it’s important to carefully consider how you structure these gifts.
Before making significant gifts or using other strategies to reduce your IHT, it’s crucial to ensure you have enough resources to cover your own financial needs. Consulting with an advisor to create a cash flow plan is recommended before making any major decisions.
Conclusion
With more people potentially falling under the IHT threshold due to rising property values, it’s vital to stay informed about how the rules apply to your estate. By understanding the available exemptions and strategies, you can take steps to reduce your inheritance tax liability and ensure your wealth is passed on as intended. Regularly reviewing your estate plan with a professional will help you navigate the complexities of IHT and make the most of the available options.
