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Inheritance tax (IHT) – your key questions answered
Inheritance tax (IHT) seems to provoke more angst and controversy than any other tax. In this article, an expert answers your most common questions.
by Colin Jelley on Jun 01, 2010 at 00:01
Inheritance Tax (IHT) is an emotive burden that has incredibly complex implications, but much potential for clever financial planning.
We asked Citywire readers for their IHT questions. Colin Jelley, head of tax and financial planning at investments and pensions provider is the man with the answers.
How does the double IHT allowance works for husbands/wives? Does it apply to other kinds of joint owners?
In October 2007 the government announced changes to the use of individuals’ nil-rate bands. The changes allow a claim to be made to transfer any unused nil-rate band on a person’s death to the estate of their surviving spouse or civil partner. This will enable the unused nil-rate band to reduce the IHT liability on the surviving spouse or civil partner’s estate upon the event of their death.
For example, Mr and Mrs Wright are married. Mrs Wright dies on 1 November 2008 leaving her whole estate to Mr Wright (therefore leaving 100% of the nil-rate band available). Mr Wright dies on 1 May 2009 – his executors have his available nil-rate band and can claim to transfer Mrs Wright’s unused nil-rate band – for tax year 2009/10 (and for 2010/11) this would equate to £650,000 (£325,000 x 2).
Whether to use the nil-rate band on first death, or to allow it to be carried forward until second death will depend on various factors of your personal situation and your financial adviser will be able to explain how the transferable nil-rate band can be claimed and whether this approach is suitable for you.
If I did not give my £3000 away last year can I give double this year?
Under the annual exemption, a person can give away £3,000 in any one tax year free from IHT. This can be carried forward but only by one year, and only where the full allowance is used for the current year.
So for example, if you gave nothing in the 2008-9 tax year, you could give away up to £6,000 in the 2009-10 tax year. However, if instead you gave away £3,000 in the 2009-10 tax year that would count as that year’s allowance rather than the previous year’s. You would be able to give away £3,000 again in the 2010-11 tax year, but not £6,000.
Can you explain the rules governing the maximum that can be given away up to seven years prior to death, and is it per person (typically husband/wife)? Ideally one would give away most of surplus funds seven years before death. Once this maximum has been reached is there any way surplus funds can be given away? Any ideas gratefully received.
Inheritance tax is due if your estate – including some assets held in trust and some gifts made within seven years of death – is valued over the current Inheritance Tax threshold (£325,000 in 2010-11). The tax is payable at 40 per cent on the amount over this threshold.
Some gifts can be made free from IHT under a number of different exemptions. Under the spouse/civil partner exemption there is no IHT to pay on transfers between most married couples or civil partners (as defined by the civil partnership Act 2004) whatever the amount. An exception is for those married to a non-UK domiciled spouse/civil partner where the exemption is limited to £55,000 after the nil rate band has been taken into account. Effectively the amount liable to IHT is generally deferred until the death of the second spouse/civil partner.
Under the annual exemption, individuals are entitled to give away £3,000 in total, in any tax year, free from IHT. Where the full £3,000 is not used in one tax year it can be carried forward to the next if required. This means a married couple could give away a total of £6,000 a year to their children without incurring IHT (or £12,000 if the previous year’s allowances were unused).
Under the small gift exemption you can make outright gifts of up to £250 in total, to each of any number of people in one year, and these will be exempt from IHT. The total of any one person’s allowance cannot form part of any larger gift.
Other exempt gifts include cash or gifts for weddings or civil partnership ceremonies. On these occasions parents can each make gifts worth £5,000, grandparents £2,500 and anyone else £1,000 and these will be exempt from IHT.
Regular gifts out of income may also be exempt from IHT.
Finally, lifetime gifts for the upbringing of children and other dependants are free from IHT liability. Also exempt are gifts and bequests to charities, political parties, universities, gifts for national purposes and gifts for public benefit.
Some gifts are considered as potentially exempt transfers (PETs) and are not liable to immediate IHT. These can be outright gifts to individuals, or gifts into bare trusts (where there is a named beneficiary which cannot be changed). After seven years the PET will fall outside your estate for IHT purposes. However, should you die within seven years the PET will become chargeable and IHT will be due at up to 40% on the gift amount after deduction of any available nil rate band. This percentage may be reduced by taper relief if you die between three and seven years after making the gift, which reduces the tax due on a sliding scale.
Other gifts are considered as chargeable lifetime transfers (CLTs). These would be gifts into a trust, other than a bare trust. If the CLT amount exceeds your available nil-rate band it can be subject to IHT at 20% at outset. Should you die within seven years, additional tax may be payable on a CLT, which again may be reduced by taper relief. There is no refund on any overpayment of tax paid during your lifetime. It is also important to note that entry, exit and periodic charges will apply to these trusts.
There is no maximum limit to how much can be given as a PET or CLT, but tax may be due.
My wife & I are joint tenants of our home in London; no mortgage, two children (ages 15 and 10). The house is worth a few pounds, more than the IHT nil rate band. We are thinking of using the ‘IOU’ debt scheme to minimise IHT. How does the scheme work?
These schemes were attractive to some couples, as they were designed to enable both people to use their IHT nil rate band. Following the change in October 2007 which introduced the concept of transferable nil rate bands, these schemes have become less attractive in some situations. The Phizackerley case also highlighted the need for advice in this area. The schemes are complicated and should only be set up with expert advice, as some couples are better off relying on transferable nil rate bands and others on these schemes.
I am continually irritated by the frequent reference to IHT as a 'voluntary' tax, inferring that it is easy to avoid if one takes the right steps. In practice I find it far from easy, am I missing something?
Inheritance tax has been referred to, colloquially, as a ‘voluntary’ tax. The idea behind this is that if you give enough money and assets away in your lifetime you will not leave an IHT liability. The answers I’ve given to some other questions here may give you some ideas, and I understand your frustration with this label, but financial advisers who specialise in this area may have some helpful tools which can help you mitigate the effects of this tax.
I am past pensionable age with two primary school children. My income is very modest but have lifetime savings. How do I cover the continuing needs of young children if I am not around?
When you have dependent children it is absolutely right to consider how they could be supported financially if you were not around. But when considering the needs of your beneficiaries you need to consider more than just inheritance tax, such as income protection, life cover, trusts and investment products. It would be worth speaking to a financial adviser who would look at your financial situation today, get a picture of your financial goals (including protecting your children should you die) and help you create a plan that not only mitigates any IHT issues, but also considers your financial goals for the future.
Do husband and wife need to draw a will to give away their half to the spouse to safeguard to nil bands? Or do they need to make any other arrangement in case a future government backs out from present arrangement of two nil bands for the surviving spouse?
Writing a will and keeping it up to date is an essential part of IHT planning. Many people wrongly believe that their whole estate will go to their spouse or civil partner when they die. However, this is only certain to be the case if a will has been drawn up and provides for this to happen.
Writing a will means you can specify exactly how you would like your assets to be distributed after your death and allows you to name your executors as well as guardians for your children. It can also be used to reduce your tax bill.
Even if you have a will, it should be up to date and reflect your wishes, your assets and your current tax position. Marriage, civil partnership, divorce or dissolution can all have an impact on an existing will.
If a person dies without having made a will, then they are said to have died ‘intestate’. In such cases a variety of problems can arise. Firstly assets will be distributed to individuals according to the intestacy rules rather than to those chosen by the deceased. Secondly there may be delays in the settling of a deceased’s affairs, which could prove distressing for surviving family members. Thirdly, an avoidable IHT bill may be incurred.
What is the best way to provide money to your grandchildren in order to reduce any payment of inheritance tax?
Certain gifts can be made to grandchildren that will be exempt from IHT.
Each grandparent can give away up to £3,000 a year under the annual exemption free from IHT. A further gift of up to £250 can be given to any number of people in a tax year under the small gift exemption, again free of IHT. The total of any one person’s allowance cannot form part of any larger gift. For instance, you would be able to give a single grandchildren either part of the £3000 annual exemption allowance or a gift of up to £250, but not both.
Regular gifts out of income could be made and providing these meet certain criteria, can be free of IHT.
If your grandchildren marry, a grandparent can give cash or gifts worth up to £2,500 as a wedding or civil partnership gift.
If you plan on making larger gifts than these, they may be subject to inheritance tax so you should seek financial advice before taking action.
Some gifts are considered as potentially exempt transfers (PETs) and are not liable to immediate IHT.
The information above provides generic information on Inheritance Tax issues. It is not, and should not be construed as, investment advice. Neither Skandia nor Colin Jelley are authorised to provide investment advice. The answers below are based on Skandia’s interpretation of the law and HM Revenue and Customs practice as at September 2009. We believe it is correct but cannot guarantee it. Tax relief and the tax treatment of investments may change. The value of any tax relief will depend on the individual’s circumstances.
* This article is an abridgement of two articles which first appeared on Citywire in September 2009.
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