Inheritance tax allowances, reliefs, exclusions and exemptions
Inheritance tax is primarily a charge made on your assets at the time of your death. However, in addition:
- If you make gifts in the 7 years up to your death, these may also incur an inheritance act charge.
- If you give an asset away (such as your house) but still use it, inheritance tax may also be due (see ‘Gifts with a reservation of benefit‘).
Not all gifts will result in an inheritance tax charge as there are various allowances that can be used.
Inheritance tax allowances
The main inheritance tax allowance is £325,000 – this is called the ‘nil rate band’. No inheritance tax is payable on assets you own at the time of your death up to this value. This rate will be in force until at least 5 April 2021.
In addition, you have a ‘Residence Nil Rate Band’ (RNRB). This can be used where you give property in your Will to a direct descendant (for example, a child or grandchild).
Currently the RNRB is £150,000 (2019/20 tax year). It will increase to £175,000 in the 2020/21 tax year.
Each person therefore has an allowance of up to £475,000 on which they will pay no inheritance tax (depending on how much of the RNRB they are able to use).
Inheritance tax is charged at 40% on anything over this amount.
The Residence Nil Rate Band
To take advantage of the Residence Nil Rate Band (RNRB) which came into force 6th April 2017, it is necessary to leave your home to a direct descendant. A direct descendant includes a child, grandchild, adopted, step or foster child, and the spouse or civil partner of each of those beneficiaries.
In addition, if you downsize or sell up before death, the RNRB may still be available.
However, if your estate is worth more than £2 million, the allowance is tapered. As a result, estates worth £2.2 million or more will not benefit from the RNRB.
Married couples and civil partners
Assets left in a Will to a spouse or civil partner are not subject to inheritance tax, regardless of their value. So for example, if a husband leaves his wife his whole estate worth £500,000, no tax is charged on his death.
In addition, because he did not use 100% of his inheritance tax allowances, his wife’s estate will benefit from a 100% increase on the nil rate band allowance applicable at the time of her death plus 100% uplift on whatever Residence Nil Rate Band is in force at the time of her death.
Potentially, therefore, a husband and wife can pass on £950,000 to their children, free from inheritance tax (£1 million from 2019/20 tax year).
Care should be taken however – leaving your entire estate outright to a spouse has its risks which we will discuss later.
Gifts made to charity are not subject to inheritance tax. In addition, if you give 10% of your net estate to charity, any Inheritance Tax payable is reduced from 40% to 36%. Of course, this saving will only be useful if the value of your estate exceeds your nil rate band and Residence Nil Rate Band.
Lifetime gift exemptions
Making gifts during your lifetime can help reduce the amount of inheritance tax payable on your death. However, as noted above, gifts made in the 7 years prior to your death can be subject to inheritance tax when you die.
Fortunately, there are some exemptions and some are very generous. Note that these are individual, so a husband and wife or civil partners EACH have these exemptions. These only apply to lifetime gifts, not to any gifts made in your Will.
Each tax year you can gift up to £3,000 without any inheritance tax implications. If you gifted nothing last year, last year’s allowance can roll over (for one year). For example:
Ben has not made any gifts previously.
- He gives his daughter £6,000 in 2014.
- He gives his daughter £6,000 in 2017.
He does not make any other gifts. All of these gifts have no inheritance tax implications. In 2014, he is also using his annual £3,000 allowance from 2014 which has rolled over. In 2017, the annual allowance from the year before has rolled over too. Note that the fact he didn’t gift in 2015 is irrelevant – you can only rollover one year.
Weddings and civil ceremony gifts
You can give up to:
- £1,000 per person, or
- £2,500 to a grandchild/great grandchild, or
- £5,000 to a child
As noted above, these allowances are individual, so parents could each give their child £5,000, resulting in a gift of £10,000 without any inheritance tax implications.
Gifts out of your surplus income
This is potentially one of the most valuable allowances currently available. You can gift as much as you like out of your surplus income, provided that you are able to maintain your standard of living after making the gift.
It is essential that you keep accurate records if you use this allowance, so that your executors know that inheritance tax should not be paid on these amounts.
Gifts to charities or political parties
These can be made without inheritance tax consequences.
Gifts to help with someone’s living costs
This is a little-known allowance that allows you to pay money to a child under 18 or an elderly relative to help with their living costs, without IHT consequences.
Gifts to a spouse or civil partner
These can be made without inheritance tax consequences.
You can give an unlimited amount of gifts up to £250 per person in each tax year, without inheritance tax consequences, provided that you haven’t used one of the other allowances on that person.
Aside from the small gifts, the above allowances can be combined to make a substantial sum – so, for example in one year, EACH parent can use their wedding gift allowance and EACH can use their annual allowance on the same child.
Lifetime gifts subject to Inheritance Tax (where an exemption does not apply)
If you make a gift in the 7 years prior to your death and one of the above exemptions does not apply, this is known as a ‘Potentially Exempt Transfer’. If you survive for 7 years, it has no inheritance tax consequences. If, however, you die within 7 years, inheritance tax may be payable on a sliding scale.
If the gift falls within your nil rate band (£325,000 + the RNRB if applicable), no inheritance tax is payable.
Otherwise, the following rates apply:
- Gift made less than 3 years before death : 40% inheritance tax due
- 3 to 4 years : 32%
- 4 to 5 years : 24%
- 5 to 6 years : 16%
- 6 to 7 years : 8%
- 7 or more years : 0%
Gifts made into a trust during your lifetime are chargeable transfers (unless one of the exemptions applies) and 20% Inheritance Tax is payable on amounts over your nil rate band which is cumulative. The amount of nil rate band available for any lifetime chargeable transfer is reduced by the total value of chargeable transfers made in the seven years prior to that lifetime chargeable transfer.
If you have business or agricultural assets that you leave in your Will, inheritance tax relief may be available. Business property relief and Agricultural property relief both work to notionally reduce the value of the asset by a percentage.
For business property, that percentage is 100% for:
(a) a business, or an interest in a business (such as a share in a partnership); and
(b) unquoted shares.
Or 50% for:
(a) quoted shares which gave the transferor control of the company; and
(b) certain land, buildings and machinery owned by the transferor but used by their company or partnership.
Agricultural property relief is available where property must have been owned and occupied for agricultural purposes immediately before its transfer for:
- 2 years if it has been occupied by the owner, a company controlled by them, or their spouse or civil partner, or
- 7 years if occupied by someone else
The rate is either 50% or 100% depending on circumstances.
Property that falls outside of your estate
Some property does not ‘count’ when calculating inheritance tax because it does not actually fall into your estate. One of the most common examples is life assurance policies where these are written in trust for a named beneficiary. Where this is the case, the proceeds are payable directly to that person, not to your estate.
Another example is a pension fund where the pension trustees can make a discretionary lump sum payment to a person of their choosing. Usually you would leave a Nomination of Benefits Letter to say who you’d like to receive the money – but the trustees do not have to follow your wishes. For example, if at the time of your death you were married with children but you had failed to update your Letter for many years which nominated a former girlfriend, there is a good chance the trustees would pay out to your spouse!
Some property is classed as excluded and does not affect the inheritance tax position. The most common example is ‘an interest in remainder’ that follows a ‘qualifying life interest’.
In 2005, William puts Rose Cottage in trust for George for life, remainder to Charlotte.
While George is still alive, Charlotte has an ‘interest in remainder’. Assume that Charlotte already owns a lot of property which takes her over the nil rate band/RNRB. If she gives her interest in remainder to Louis while George is still alive (i.e. before the cottage comes to her), there will be no Inheritance Tax implications and no Capital Gains Tax either.
Trusts can ensure your assets go to your intended beneficiaries rather than passing outside of the family.
Many people choose to create a trust in their Will rather than an outright gift. They will choose trustees to manage the trust and look after the interests of the beneficiaries.
The main types of trust are:
With this type of trust, you can leave the benefit of an asset to one person for life, with the remainder to another person.
- You leave your share of the family home to your spouse, remainder to your children. When your spouse dies, your children become the owners of the home absolutely.
- You own shares in Company XYZ. You specify that your spouse should receive the dividends from those shares for life, remainder to your children. When your spouse dies, your children become owners of the shares absolutely.
Why is this type of trust attractive? Because it preserves the asset and keeps it in the family – whatever happens to your spouse, the asset is safe for your children.
Compare this to a Mirror Will where you leave everything to your spouse, then the children:
- Your spouse can make a new Will after your death which excludes one or more of the children
- Your spouse can remarry, making their new partner first in line to inherit everything
- Your spouse may go into care and the entire value of the estate may be used for care fees
- Your spouse may run into financial difficulties and the assets may be depleted
As you can see, Mirror Wills have a lot of risks. These are just some examples of why creating a life interest in your Will is a good idea.
For inheritance tax purposes, the ‘life tenant’ – the person who has use of the asset during their lifetime – is treated as owning it. When they die it is counted as part of their estate when tax is calculated.
Discretionary trusts allow the trustees to distribute to a class of beneficiaries. For example, you might specify that your brother and sister will be trustees and your three children will be the beneficiaries.
The huge benefit is their flexibility – you cannot possibly know what the circumstances of your children or grandchildren will be on your death. One child may be doing particularly well while another has very little – and an equal split in these circumstances may be unfair. Likewise, if they are just going through a divorce, the last thing you want is for your hard earned wealth to form a part of their divorce proceedings.
The downside often quoted is taxation. They can be subject to 10 year anniversary and exit charges, together with unfavourable income tax charges. However, to dismiss them on this basis ignores a huge opportunity that they present.
First, the very nature of a discretionary trust is that no beneficiary is absolutely entitled to the assets it contains. If at the time of your death your children are going through a divorce or find themselves in financial difficulty, the trust assets are not at risk.
Second, if you create a discretionary trust that allows your trustees to set up further trusts, they can make all the decisions as to how the assets are disposed of within the first 2 years following your death. This means they can take all of your beneficiaries circumstances into account at that point and make decisions that are tax efficient and best preserve your wealth.
They may decide to:
- Create tax efficient trusts for your minor children.
- Create tax efficient trusts for your children who are under the age of 25, to ensure the assets are not used up before the child is responsible enough to take care of them.
- Leave some money in the trust while a child is going though divorce proceedings or has financial difficulties (which would otherwise be lost if it were paid to them).
- Leave some money in the trust while your spouse is going into care, to ensure the whole estate is not eaten up by care fees.
- Pay out money absolutely to a beneficiary in need.
- Transfer the family home to your children (none of which fortunately are going through a divorce or have financial difficulties) to take advantage of your Residence Nil Rate Band inheritance tax allowance.
In all of these scenarios, the decision is ‘written back’ into your Will as if you made it yourself, taking advantage of any inheritance tax allowances and exemptions that this brings. You can of course leave a Letter of Wishes guiding your trustees on how you would like them to act.
Of course, this may require a little legal help later on, but that minor inconvenience pales in comparison with how much can be lost to care fees, ex-spouses or creditors if an asset is inherited outright at the wrong time.
NB: A discretionary trust can be combined with a life interest – so you can leave a life interest to your spouse with the remainder to your children on a discretionary trust that allows the trustees to create more trusts as they see fit.
With this type of trust, your beneficiary is entitled to the asset but the trustee holds it for them. This might happen if you gift something to a minor.
Trusts for minors
Some trusts for minors have beneficial tax treatment
Will trusts for minors may be:
- A bare trust (can be made by parents/grandparents)
- A bereaved minor’s trust (can be made by parents)
- An 18-25 trust (can be made by parents)
- An immediate post-death interest (IPDI) (parents or grandparents)
- A discretionary trust (parents or grandparents)
- A trust for person with a disability
You can find out more about Will trusts for minors here. Some of these trusts have substantial tax advantages such as not being subject to the 10 year anniversary or exit charges (or paying a heavily reduced rate). However. the choice of trust must take all other factors into consideration, including the age at which the child should inherit, what happens to the income before they inherit and whether you want the child to be deemed to own the assets before they inherit them.
One view is that rather than choosing the type of trust that would be beneficial now, you should leave the decision to your trustees (i.e. create a discretionary trust with the power to create further trusts). As noted above, any decisions they make within the first 2 years can be ‘written back’ as if you made the decision yourself. This allows them to decide what to do based on your beneficiary’s circumstances. Clearly your choice of trustees is very important if you decide to go down this route.
With proper estate planning, you can minimise the amount of inheritance tax that is paid on your death and preserve your assets for future generations. It is essential to review your Will and the value of your assets regularly – at least every 3 years and after any significant change of circumstances (see: ‘Do I need to change my Will’) April King Legal offer a free 1 hour appointment with one of our lawyers, and we also offer home visits. Get in touch to book at a time and location convenient to you.
Disclaimer: This article is intended to be a general overview of inheritance tax. It is not a substitute for professional advice on your individual circumstances.
From the blog:
In this article we look at the various types of Will trusts that can be used to leave money to minor children and the pros/cons of each type.
We look at the consequences of gifting with a reservation of benefit for inheritance tax, income tax (POAT), capital gains tax and liability for care fees.
On the face of it, the new RNRB allowance looks positive but a little thought is required to ensure that in using the allowance, you do not inadvertently expose your assets to risk.