There’s nothing more natural than a parent’s desire to ensure their family is financially secure after death. There’s also nothing more frustrating than having your home being grabbed off your kids by the taxman after you die.
Well, in as much as most people would like to blame the 21st-century greedy taxmen for inheritance tax, IHT has been around for centuries. It’s been dated back to 1796 when a tax on estates was established to help finance the war against Napoleon. The modern-day inheritance tax, however, dates back to 1894 when the government formally introduced estate duty, a tax on the cash value of the land.
So, one would ask, what’s inheritance tax1, who’s liable, how much it is, and how can you reduce its effect on your loved ones and your estate?
Well, here’s a comprehensive guide to walk you through all the nitty-gritty on inheritance tax.
Inheritance Tax Basics
Inheritance tax, or as 30% of the population refers to as ‘death duty’ is an amount of capital that your family or financial manager pays to the government after you die, depending on your estate’s worth.
When Do You Have to Pay IHT?
If you have to pay an inheritance tax amount, you’ll have to get an IHT reference number at least three weeks, before making any payment. You can do this either through post or online. IHT, however, has to be paid by the end of the 6th month after you die. If it’s not paid within the set timeframe, HMRC3 will start charging interest.
Your estate executor will choose to pay the tax on specific assets like your home, by instalments over ten years, but the overdue amount will still be subject to interest.
If your assets are sold before all the IHT is paid, the executors4 will have to ensure that they pay all the instalments, plus interest immediately.
Therefore, if your estate incurs IHT, it’d be best if your executor paid some of the tax within the first six months of the death, even if they’re not done valuing the estate – this is known as payment on account5. It helps in reducing the interest that your estate will be charged if it takes longer to sell the assets to cater to the debts and other taxes.
In case there’s an overpayment, HMRC will refund the estate once the probate has been offered.
How Much is Inheritance Tax? What’s its rate?
Well, there’s no inheritance to pay if your estate is valued below the set €325,000 inheritance tax threshold6 – it’s referred to as the nil rate band. The limit is, however, expected to rise with time, but it’s also likely to remain constant until 6th April 2021.
The new set rules also mean that if you decide to leave your estate to your kids, (including foster, adopted or step kids), or your grandkids, a house allowance of €175,000 will be available, with the possibility of increasing your threshold to €500,000.
The standard inheritance tax rate is 40% of anything in your estate that’s over the €325,000 threshold. Therefore, if you leave your kids an estate worth €500,000, the tax bill will be €70,000 (40% on the difference between €500,000 and €325,000, €175,000).
If you’re married or in a civil partnership and your estate is worth less than your threshold, any unexploited limit will be included in your spouse’s limit when you pass on. It means that their threshold can be as high as €750,000.
Moreover, when a married couple leaves a jointly owned house to their kids, the total limit will be €1million, when they include both their house allowances. Nonetheless, when this allowance is transferred between couples, the value of the transferred IHT allowance will be dependent on when the second, and not the first, partner passes away.
If you want to figure out how much inheritance tax you’re liable to pay, you can try using the inheritance tax calculator and know what strategies will help in reducing the IHT amount.
How to Reduce IHT’s Impact on Your Estate
There are numerous steps you can consider to avoid the hefty IHT implications. However, each step can have an impact on your life now. Therefore, it’d be best if you think of getting inheritance tax advice from a professional financial advisor. You might also benefit from discussing this with your family members.
With that said, here are some of the steps you need to take to reduce IHT’s impact or avoid inheritance tax entirely.
When you make a gift, you won’t be liable to paying inheritance tax, primarily if you survive for seven years afterwards. Therefore, if you offer antiques in your residence to your kids, for instance, then the value of the antiques will be excluded if you die over seven years later. It’s practically a sliding scale that’s referred to as a ‘potentially exempt transfer7.’
Gifts can be categorized as:
- Any item that has a value like cash, real estate, possessions
- A loss in value when you transfer something, for less than it’s worth, the difference in cost will be considered as a gift
So, how can you offer gifts away, and how is it considered?
Well, there are two ways you can make a gift. You can offer your family, next-door neighbour, or friend €3,000 worth of offerings each year as an annual exemption (and rollover one year’s allowance, to a maximum of €6,000).
You can also make small gift exemptions – offering up to €250 to as many people as you’d like.
Every tax year, you can make various gifts offerings like:
- Gifts to charity foundations and political parties
- Wedding or civil, ceremonial gifts of up to €1,000 per person (€2,500 for a grandkid or great grandkid, €5,000 for your child)
- Disbursements to assist with another person’s living expenses like an elderly relative or child under 18 years
Leaving Capital to a Charity
When you make payments to a UK-registered charity, you can avoid paying inheritance tax – therefore, even if you’re technically giving capital away, you’re securing 100% of its value. Your estate might be eligible to pay IHT at a reduced rate on some assets if you leave at least 10% of your net estate to charity in your Will.
The 10%, however, only applies to the amount of your estate over the lifetime allowance. Therefore, if, for instance, you were leaving behind €425,000, you’d benefit from the lower rate if you offered more than €10,000 (10% of the amount that’s over €325,000).
Leaving the Estate to Your Spouse
Your civil partner or spouse will never be forced to pay tax on assets you leave them, regardless of the amount. By making the most of this in your Will, you can save your loved ones a small fortune.
When your spouse or civil partner passes on, they’ll inherit your un-utilized personal allowance, thus enabling them to pass on up to €325,000 more as part of the primary inheritance tax allowance.
If your spouse, or you, remarried, then the unused personal allowance will be added together and distributed – but only up to the value of one full personal allowance.
Using Property Allowances
If you’re planning on leaving your estate to your kids or grandkids, the new estate allowances allow you to leave behind more of your property before tax is due. In the 2020/21 tax year, the estate allowance is worth €175,000 per person, up from €150,000 in 2019/20.
For those who’re married, the tax-free amount increases by €350,000. Therefore, including the personal allowance, property of up to €1million could be entirely free of IHT.
Taking Out Equity Release Plans
If all your assets are locked up in your home, you might not be able to offer gifts during your lifetime or spend the wealth yourself. To get around this, you can try taking out an equity release plan – a mortgage that lets you unlock the value of your residence in exchange for a lump sum or regular income.
The equity release8 mortgage scheme offers you two options: the lifetime mortgage and the home reversion plan. With the lifetime mortgage, you borrow cash against the value of your house and repay the loan amount plus interests when you die or move into residential care. With the home reversion scheme, however, you sell a part, or your entire estate at a reduced market rate.
You can choose the pass on the capital you release to your beneficiaries or spend it yourself. Provided that you survive the gift by seven years, there’ll be no tax to pay.
Taking Out A Life Insurance Policy
If you can’t beat the IHT bill, you can insure against it. Taking a life insurance policy9 is one of the best inheritance tax exemptions tactics you can consider. As long as you write the policy into trust, the payout won’t form part of your property.
HMRC typically treats insurance premiums as a lifetime gift if you pay them yourself. However, these can usually be covered by one of the tax-free exclusions – either the yearly €3,000 exemption or the ‘gifts out of ordinary income’ exemption.
Considering A Deed of Variation
A deed of variation enables your beneficiaries to make changes to your Will after you die. So, the heir can reduce their share of the inheritance and offer someone who didn’t get a percentage of the estate.
One can set up a deed of variation within two years after death, but all the affected heirs under the Will have to agree to the variation – which can be challenging when there are several heirs.
As a general rule, it’s always advised that you review your Will sporadically so that your affairs are tax-efficient. It’ll reduce the Probate Process to bare bones for your executor and lower any chances of your family squabbling.
The standard IHT rate is 40%. It’s only charged on the part of your property that’s above the threshold. Therefore, if your estate is worth €500,000 and your tax-free limit is 325,000, the IHT charged will be 40% of €175,000 (€500,000 minus €325,000).
Your estate can pay IHT at a reduced rate of 36% on some assets if you opt to leave 10% or more of the ‘net value ‘to charity.
There are various ways you can avoid paying IHT. These include:
- Considering offering gifts to your loved ones
- Leaving the capital to a charity organization
- Leaving your estate to your spouse
- Using the estate allowance
- Taking out an equity release scheme
- Taking out a life insurance policy
- Considering a deed of variation
In the 2020/21 tax year, you’re permitted to leave a house valued at up to €325,000 plus the new ‘primary residence ‘band of €175,000, giving the total inheritance tax allowance of €500,000 per person.
For property worth less than this, the heirs won’t pay any IHT.
Well, you won’t have to pay anything since the law allows one to pass a house to their loved ones when they die. If you also leave the house to another person in your Will, it does count towards the estate’s value.
Moreover, if you own a home, your tax-free threshold can go up to €500,000 if you leave it to your children and grandkids. It’ll also increase if your estate is worth less €2million