Inheritance Tax 2012 - 2013
The law allows you to leave an estate worth up to £325,000 (2012-2013) without having to pay any Inheritance Tax upon it. This £325,000 is called the 'Nil Rate Band'. After the first £325,000 or the Nil Rate Band, the remainder of your estate will be charged 40% Inheritance Tax.
It is important to know that there is no Inheritance Tax between spouses or civil partners.
Married couples, and civil partners can transfer their Nil Rate Band allowances so that any part of the Nil Rate Band that was not used when the first spouse or civil partner died is transferred to the individual's surviving spouse or civil partner for use on their death.
The transferable allowance is available to all survivors of a marriage or civil partnership who die on or after 9 October 2007, no matter when the first partner died.
Hence the nil rate band for married couples is effectively up to £650,000
How the transfer would work
Where a valid claim to transfer unused Nil Rate Band is made, the Nil Rate Band that is available when the surviving spouse or civil partner dies will be increased by the proportion of the Nil Rate Band unused on the first death.
For example, if on the first death the chargeable estate is £150,000 and the Nil Rate Band is £300,000 then 50% of the Nil Rate band would be unused. If the Nil Rate Band when the survivor dies is £325,000, then that would be increased by 50% to £487,500. (325 + 162.5)
The amount of the Nil Rate Band that can be transferred does not depend on the value of the first spouse or civil partner's estate. Whatever proportion of the Nil Rate Band is unused on the first death is available for transfer to the survivor.
Example of how the new rules work
A dies on 14 April 2007 with an estate of £400,000, which he leaves entirely to his spouse B.
B dies on 17 June 2009 leaving an estate of £600,000 equally between her two children.
When B dies the Nil Rate Band is £325,000.
As 100% of A's Nil Rate Band was unused, (because there is no inheritance tax between spouses and civil partners) the Nil Rate Band on B's death is doubled to £650,000.
As B's estate is £600,000 there is no IHT to pay on B's death.
Other IHT Tax issues
Each person has their own allowances – and a choice of what to do with them.
This means that you could reduce the value of your estate on which IHT can be levied.
Mainly by giving some of your estate away as gifts, and there are many exemptions available as explained below.
Everyone can give away £3,000, exempt from IHT, (i.e. it would not be considered part of your estate for IHT purposes were you to die) in any one tax year. It doesn’t have to go to one specified person, but the total must not exceed this total. Also, if not previously used, you could potentially backdate this one tax year so in effect you could gift £6,000 to begin with.
Marriage gifts exemption
Each parent can give a wedding gift of up to £5,000 to each child when they get married at any time before the wedding day. If it is your grandchild, you can gift them up to £2,500 each and for other family members or friends you can give up to £1,000. In addition, you can also make gifts utilising your annual exemption to the same person so potentially, as a parent, you could give your child up to £8,000 in the year they are married (£5,000 marriage gift and £3,000 annual exemption). The same goes for your partner too.
Small gifts exemption
Any number of gifts to different people, up to the value of £250 each, can be made in a tax year. However, if an individual gift exceeds this £250 then this gift must be deducted from your £3,000 annual exemption allowance instead.
Gifts of any size to political parties or charities are also exempt.
Over and above the allowances just mentioned, you can make unlimited direct gifts of cash, shares or other items of value – referred to as Potentially Exempt Transfers (PETs) – and they will be deducted from your estate providing you live for seven years from the date made.
If you die within the seven-year period the gift will be taken into account for inheritance tax, however this can reduce after the first three years. This is known as ‘Taper Relief’.
It only applies to the part of the gift that is in excess of the nil rate band (currently £325,000) and, after three years, the relief will start to reduce the amount of tax you have to pay on the gift.
After seven years, it becomes exempt from IHT completely.
The table below illustrates this.
Period of Years
% of Tax Payable
E.g. if you gave your daughter £500,000 and if you survive 7 years after this, it would not be considered as part of your estate, and hence not subject to IHT.
Type of gifts
You can give away most assets, including cash and shares. However, it has to be an outright gift from which you can no longer benefit. This excludes giving away your family home. If you hand it to your children and continue to live there then this is classed as a ‘gift with reservation of benefit’ and you may still be liable for IHT on the full value of your house. You may get around this by paying your children a rent, so that you technically become their tenant, although the taxman will wish to see that this rent is at the ‘going rate’, and not just a nominal payment, hence these rental payments can wipe out the tax benefits.
Always make a note of such gifts to pass on to the executor of your will.
However, you must be sensible. It is your hard earned money, saved by you, for you. None of us can know what is around the corner, and what our future needs might be. Once you have given your cash away to your children, it may be very difficult to ask for it back again.
The first thing to do is to work out if inheritance tax will be an issue for you. Add up the value of your savings, investments, properties and other personal possessions. Don't forget to include funds held in an Isa or Pep. Although they are tax-free during your lifetime, they are subject to death duties. Then subtract any outstanding debts you have, e.g. mortgage, loans, credit card bills. Then you will know the size of your estate and how much over the Nil Rate Band threshold you may be and whether you need to make any plans to avoid IHT.
Don’t give your home away
Be very very careful with your property, some people perceive it a good idea to give their homes to their children, but in order to escape IHT consideration, it would have to be an outright gift from which you can no longer benefit, you would therefore have to pay your children rent at the current market value, if you wanted to remain living there. This may wipe out any tax benefits. Furthermore if you children become divorced or bankrupt you may find yourselves homeless as your home is now part of their estate.
Life Insurance Policy
You could take out life insurance to cover the IHT bill. E.g. if you calculate that your IHT tax bill will be £50,000, you could take out life insurance for this amount.
Money arising under policies of life insurance can be directed to a third party with a minimum of formality.
The policyholder can create an implied trust in favour of a spouse, and or children. Alternatively, to benefit others, an expressed trust of the policy proceeds may be declared. In these cases, effectively, the money belongs to the beneficiaries under the trust from the date of the declaration and does not form part of the estate of the deceased at death. The money is not, therefore available for the payment of the debts of the deceased's. Such policies may be setup to provide cash to pay for a mortgage or inheritance tax. Where a policy is taken out purely to benefit beneficiaries, since the policy money is paid on proof of death, the money may be lent by the beneficiaries to the PRs to pay the tax.