Liability to Inheritance Tax can be huge, amounting to hundreds of thousands of pounds.
What is inheritance tax?
Upon death the Government assesses how much an individual’s estate is worth; this includes cash, investments, and any property or business owned. If this exceeds the Inheritance Tax threshold set by the Chancellor, the estate will be taxed at 40% on any amount of money above the threshold.
Inheritance Tax is designed to redistribute income – some of the money goes to the State to benefit the country as a whole. Many consider this an unfair tax, because the earned assets of the estate have already been taxed. Inheritance Tax is effectively a double tax. After many years of escalating property prices, many more people are falling liable for hefty Inheritance Tax bills.
The nil-rate threshold
Currently estates valued at £300,000, or less, are not liable for Inheritance Tax. This is called the ‘nil-rate threshold’. This is scheduled to rise progressively over the coming years, reaching £350,000 by 2010.
Above the nil-rate threshold, assets of an estate are taxed at 40%. So for example, if you leave behind assets worth £1000000, your estate pays nothing on the first £300,000, and 40% on the remaining £700,000 – a total of £280,000 in tax.
The nil-rate threshold for married couples
When an individual dies any assets left to their spouse or registered civil partner, provided they are UK residents, are exempt from Inheritance Tax. In addition, the Inheritance Tax allowance passes to the surviving partner, increasing it from £300,000 to £600,000, providing nothing is bequeathed to children or other beneficiaries at this stage. So the surviving partner could leave up to £600,000 tax-free. This is illustrated in the following example:
Mr and Mrs Smith have assets worth £750,000. Mr Smith dies first, leaving £200,000 to the children. The remaining £100,000 of his nil-rate allowance will pass on to Mrs Smith, giving her a total Inheritance Tax allowance of £400,000. When Mrs Smith passes on leaving an estate of £550,000, she will owe 40% on everything left behind above £400k, that is £60,000 (40% of £150,000) will be payable in Inheritance Tax, leaving £490,000 to her children
How to reduce the Inheritance Tax bill
Assets given away before death can still be counted as part of the estate, and hence be subject to Inheritance Tax, if death occurs within 7 years of giving the gift. So it is best to be generous before getting old. However, there a range of exemptions worth taking into account to help lessen the tax bill.
- Annual Inheritance Tax Exemption. The first £3,000 given away each tax year is not subject to Inheritance Tax.
- Gifts to charities and political parties are Inheritance Tax free.
- Gifts of £250 each year are Inheritance Tax free. Gifts not exceeding £250 to any one recipient per tax year are excluded from Inheritance Tax.
- Gifts from income. Inheritance Tax is a tax on assets. Gifts sourced form a pension or earnings are not taxable.
Gifts on consideration of marriage. If a gift is given that is conditional on an agreement of marriage is Inheritance Tax exempt. There are limits to this though: £5,000 for a gift from a parent, £2,500 from a grandparent, £1,000 from anyone else.
The gift must be a genuine unconditional gift with no gain involved.