Maligned by some and celebrated by others, Inheritance Tax affects the estates of those who have passed away. This includes any assets, such as property, possessions and money, with the tax bill falling at the feet of those who have inherited these assets. Obviously, this can be a source of anxiety for some, who don’t want to leave their loved ones with a hefty tax bill. Fortunately for most, the threshold at which inheritance tax is applicable is relatively high. However it’s still worth checking out how inheritance tax works and whether it does actually effect you.
What is Inheritance Tax?
Inheritance tax was introduced as a way to disrupt generational wealth and therefore attempt to redistribute money. The idea being that those who are born to rich families will remain rich through inheritance and this cycle will continue. As you can imagine, this can be a controversial policy with strong feelings on both sides. Whatever your feelings on this tax, it’s here to stay and therefore it’s important to know how it actually works.
The threshold for inheritance tax is £325,000, with everything above this number being subjected to a tax of 40%. If you’re leaving the inheritance to a spouse or civil partner, then no tax is applied.
This may seem relatively simple at first but there are many caveats to this rule, with thresholds and percentages changing according to circumstances.
For example, the tax-free allowances increases if you leave your home to a direct descendent- children or grandchildren. This is known as the residence nil-rate band or main residence band and adds another £175,000 to the standard £325,000 threshold. This adds up to a tax-free allowance of £500,000 if you fit the criteria of the main residence band. However, if the estate in question is worth more than £2 million then the main residence allowance will be reduced by £1, for ever £2 above the £2 million threshold.
Reducing Inheritance Tax
Of course, everyone should pay their fair share of tax and this includes inheritance tax but there are ways in which you can reduce this burden.
It’s important to note that marriage can actually double your inheritance-tax allowance. Those who are married or in a civil-partnership can use both of their allowances together, as long as they haven’t been used before. Therefore, someone who is utilising the main residence band would see their £500,000 allowance double to £1 million, when combined with that of their partners.
Some people will choose to give away gifts to their loved ones while they’re still alive, as a way to avoid the inheritance tax. However, these gifts are still subject to the tax, as long as they were made within seven years of the person dying. It’s worth noting that the time of the gift being made does affect the percentage that is taxed, this is known as taper relief. For example, if the gift is made within three years of the person dying, it’s subject to the normal 40% but this reduces to 24% (4-5 years), 15% (5-6 years) and 8% (6-7 years).
Speaking of gifts, there are relatively small gifts that can be made, which aren’t subject to any inheritance tax at all. For example, £3,000 can be given away each year and it doesn’t affect your taxable allowance. You can also gift £250 to everyone you know, each and every year and this doesn’t affect your allowance either.
Any gifts made to a political party or a charity, no matter how large or small, are completely inheritance tax free.
As inheritance tax is a tax on assets, it’s not applied to earnings and therefore you can give away money from earnings, without being taxed. This includes any sort of income or pension, however it’s only applicable if it doesn’t affect your standard of living. For example, if you give away enough earnings that you’d need to rely on assets.
Finally, as inheritance is often a way in which to help loved ones, particularly children and grandchildren, HMRC does take this in to account. For example, wedding gifts are considered inheritance tax free, but there are different allowances (£5000 from a parent, £2500 from a grandparent and £1000 from anyone else). You can also help with your children’s university expenses and all of these payments are tax free, as long as the child remains in full-time education or training.
As we have established, inheritance tax can be complicated, with lots of moving parts to consider. Fortunately, the experts at Salhan Accountants offer an estate and inheritance tax planning service, providing peace of mind and ensuring the best decisions are made.
