The number of estates subject to inheritance tax (IHT) has been steadily rising over recent years. Current inflation together with the main allowances for IHT being frozen until at least April 2028 means the number of people whose estates may now be subject to IHT is rising at a much more rapid rate.
What is Inheritance Tax (IHT)?
IHT is the tax levied on the estate of a deceased person or on certain transfers of value in a lifetime. There are many exemptions, reliefs, and allowances for IHT, but these often go unused leading to more IHT being paid than necessary.
Some of the main ways to maximise the use of the available allowances, reliefs and exemptions and reduce the exposure to IHT are:
- Gifting in lifetime
- Trust
- Family investments companies
- Utilising the allowances
- Tax efficient investments
Gifting in lifetime
Where the desire is to pass assets or wealth onto the next generation or to other family or friends, direct gifting can be the simplest option and there are a number of allowances and exemptions for this which result in the gifts being immediately exempt from IHT.
Annual exemption
Up to £3,000 can be gifted per person, per year to one or a number of individuals. The exemption applies to the person making the gifts, so it is £3,000 in total not per person the gifts are made to. For example, a parent with 3 children could gift £1,000 to each child per year to utilise this exemption. When unused, the exemption can be carried forward for up to one year.
Small gifts exemption
Up to £250 can be gifted to as many individuals as desired.
Gifts on marriage
On the occasion of a marriage, a gift can be given to the couple that will be IHT-exempt. The amount will depend on the relationship of the couple getting married.
Gifts from surplus income
Where an individual has income in excess of their requirements, if nothing is done, this will usually accumulate within a person’s estate, increasing their exposure to IHT.
Instead of accumulating, the excess can be gifted each year. If the gifts are regular and can be shown to be from excess income, these will be immediately exempt from IHT.
Potential Exempt Transfer (PET)
Where gifts are made to individuals in excess of these allowances and exemptions, the gift becomes a potentially exempt transfer (PET).
If a person who makes a PET, lives for seven years from the date of the gift, the full amount is exempt from IHT. If less than seven years are survived from the date of the gift the amount becomes taxable but if it has been more than 3 years, the amount taxable will be tapered.
Please note: On all gifts, where the asset being gifted is not cash, capital gains tax must be considered too.
Trusts
There are many situations in which there is a desire to pass on assets but not to gift them directly to individuals. This is often the case where the intended recipients are too young (everyone has a different opinion on what this age is), or when the intended recipients are vulnerable for any number of reasons. In this case, cash or assets can be gifted to a trust and held by trustees for the benefit of those for whom the gifts are ultimately for.
Trusts are often used where there are specific assets to be passed down the direct generations while protecting them such as from divorce or other issues over the years. A trust can allow an individual to pass on an asset and while they usually cannot continue to benefit from the asset, they can maintain an element of control over the asset.
Family investment companies
Where there are significant assets that the owners still require to benefit from but would like to share with the family, a family investment company can be appropriate for this. It can allow the assets and any income they generate to be shared with the family to reduce the IHT exposure for the original owners while not relinquishing all benefits from the assets.
Utilising the allowances
Nil Rate Band & Residential Nil Rate Band
Two of the most valuable allowances for IHT are the nil rate band (NRB) which is currently £325,000 and the residential nil rate band (RNRB) which is currently £175,000.
Together these allowances give an individual up to £500,000 of an estate with no IHT payable and up to £1 million for a couple.
However, the RNRB has some limitations as it only applies to people whose estates are valued at more than £2 million. Additionally, this allowance is only accessible if you have a main residence in your estate or have had one in the past. If you pass on your property and the money you gained from it to your children and grandchildren, they can benefit from this tax allowance. However, nieces, nephews, and other family members won’t be eligible for it.
Tax efficient investments
There are assets that can qualify for agricultural property relief or business property relief. Assets that qualify for either of these where they meet all the relevant conditions can mean no IHT will arise on these assets as they are taxable at 0%. This is a hugely valuable relief and there are many ways to invest in assets that meet the conditions.