Inheritance tax is possibly one of the most contentious taxes in force but is also one which can, in the right circumstances, be mitigated with relatively straightforward planning. A record £5.4bn was paid in the past financial year and forecasts from insurer Canada Life suggest that IHT receipts will bring in £10bn a year by 2030.
So if Inheritance tax planning can reduce the burden, why don’t more people actually plan to do this? Well, there still remains a fairly widespread lack of understanding in the way the rules are applied and some common ‘myths’ that make people believe that their overall inheritance tax position is lower than it actually is. Do any of the following sound familiar to you?
1) IHT only applies to the super wealthy so why do I need to worry
Statistics show that over 50% of the total annual receipts from inheritance tax is paid by estates within the South East. High property prices often mean that the value of your home alone can bring you within the inheritance tax net resulting in a 40% tax bill. Each individual benefits from a ‘nil rate band’ which is currently set at £325,000 but with the price of a first home in the South East being in the region of £275,000 it is clear to see how IHT could affect a much wider number of estates in this area.
2) My partner will inherit all of my estate so no IHT will be due on my death anyway
Whilst transfers between spouses may be exempt for IHT there are a few points to bear in mind here. Firstly, you should ensure that you have a will drawn up to this effect. If you die without a will the rules of intestacy will be used to determine who benefits from your estate and this may mean that not all of your estate passes to your spouse and may become chargeable. If your spouse is non UK domiciled there is a limit to how much can pass to them under the exemption which again may result in part of the estate being chargeable to IHT. Perhaps the biggest misconception here though is the concept of ‘Common Law Spouses’. If you are unmarried at the date of your death, not only would your partner have no automatic rights under the intestacy rules if you die without a will, there is no exemption at all for any assets that pass to them and the estate may be fully chargeable.
3) Isn’t the IHT threshold before you have to pay tax now £1m, so even taking into account the value of my home I’m unlikely to have an estate worth more than this
The fabled £1m limit was often quoted in the press (and by the government!) when the new ‘residential nil rate band’ was introduced where you passed on your main residence. The maximum residential nil rate band will increase to £175,000 in 2020/21. Adding this to the current nil rate band means that each individual will potentially have a ‘threshold’ of £500,000 giving us a the £1m threshold per couple. However, the residential nil rate band comes with some strict conditions and where these aren’t met it won’t be available. Perhaps the most ‘unfair’ of these is that the home must be passed down to lineal descendants so couples that have not had children will not be able to benefit. The rules are complex and careful planning is needed to ensure the residential nil rate band can be maximised.
4) I can save IHT by gifting my home to my children/trust now and provided I survive 7 years it will fall outside of my estate completely
A very common question however the counter question is always the same. So where are you going to live then? In almost all cases the response will be ‘well I’ll just continue to live there – the kids won’t mind’. Unless you’re willing to pay a full market rate to your children to continue living in the home, the value of this will remain within your estate for IHT purposes all the time you remain in occupation. There are anti-avoidance rules referred to as the ‘gift with reservation’ rules which ensure that any gifts made during your lifetime will still be fully chargeable in your estate when you die if you continue to benefit from the asset. What’s worse in this situation is that not only does the full value end up being chargeable to IHT, your children would not get the benefit of having the ‘value’ uplifted to market value at the date of your death so when they sell the property capital gains tax may also be due.
5) If I make a gift but don’t survive 7 years the chargeable value in my estate is reduced for each year I have survived
There is a measure of ‘taper’ relief if you survive for at least 3 years after making a gift. However, while most people think that it is the value of the gift itself which is tapered this is not correct and it is the rate of tax that is reduced. If the gift falls within the available nil rate band at death then there is no tax to pay on and therefore no relief at all. However, more of the value of the estate upon death is taxed at 40% as there is less nil rate band available.
You might find that your view of Inheritance tax has now changed and may want to consider what options you have to reduce the exposure. On the other hand, you might still be of the view that if your beneficiaries inherit 60% of your estate they should count themselves lucky. It is your choice either way but you should make sure its based on sound advice not any common myths. If you want to learn more then contact us on 01892 507288 and arrange a free, no obligation initial meeting.