An important aspect of estate planning is understanding Inheritance Tax (IHT) and what methods can be employed to mitigate it. Understanding the impact that IHT will have on a person’s estate is key as this will have an impact on what the best options are available with regard to their will planning. In this article we will discuss the basics of IHT, when it is charged, and what exemptions and reliefs are available.
What is Inheritance Tax?
In simple terms, IHT is a tax charged when wealth changes hands, primarily charged on death but may also arise at points during a person’s lifetime and also on trusts under the relevant property regime. Its full legal definition is that it is a charge on transfers of value.
Every person has a Nil Rate Band (NRB) available to them. Any assets up to this value will not be charged IHT. Assets above the NRB will be charged. The current value of the NRB is £325,000.
Since 6 April 2017, each person also has a Residential Nil Rate Band (RNRB) available to them. The RNRB is complex and is not covered in this article in detail. In short, RNRB will be available if a person passes their share in their main residence to their descendants on death. The value of the RNRB is currently £175,000 and at the end of the 2020-2021 tax year, the value of the RNRB will increase in line with inflation based on the Consumer Prices Index.
Unused NRB and RBRB can be transferred to a surviving spouse or civil partner to be used on their death. This can mean that up to £1,000,000 can currently be gifted tax free on a surviving spouse or civil partner’s death.
When is Inheritance Tax charged?
IHT will either be charged on death, or at certain points during lifetime.
On death, IHT will be charged in relation to the deceased’s estate and will consider the value of the estate at death, along with gifts made within 7 years of death (Potentially Exempt Transfers) and Gifts with Reservation of Benefit. The rate of IHT for anything over the NRB and RNRB on death is 40%. This however can be reduced to 36% if 10% or more of the estate is left to charity although the rules for this in practice can be complex.
During lifetime, IHT is charged on gifts to relevant property trusts and certain gifts to companies. The rate of IHT for gifts above the NRB is 20%.
IHT charges can be due under relevant property trusts on every ten year anniversary of its creation (anniversary charges) and when capital is distributed to beneficiaries (exit charges). The calculation of these charges is complex but roughly this will not exceed 6% of what is over the NRB.
Inheritance Tax Exemptions and Reliefs
There are number of different exemptions and reliefs for inheritance tax that can be claimed during lifetime or on death. The following are some of the common exemptions and reliefs.
- Gifts to a surviving spouse or partner are free of IHT due to the spousal exemption.
- Gifts to charities and qualifying political parties are free of IHT.
- Certain business and farming assets can qualify for either a 50% or 100% relief from IHT.
- Each person has an annual exemption of £3000 per year that can be gifted in any way that will not be considered for IHT. An unused allowance can be rolled over to the next year once.
- Small gifts totalling £250 per individual per year are exempt from IHT.