The tax benefits of leaving a legacy
by Dawn Moir, Head of Wills, Trusts & Probate, Goughs Solicitors
Everyone has to pay Inheritance Tax on their assets over a certain amount when they die but it’s good to be aware that there are several exemptions that could help cut your Inheritance Tax bill or even reduce it in full.
This article aims to provide you with information on the basic tax rules around Inheritance Tax planning, helping you to understand the current rules and types of gifts you can leave either without incurring any costs or reducing them.
When a person dies their estate is valued for Inheritance Tax. There is a threshold above which the estate will then pay Inheritance Tax which is known as the Nil Rate Band. The Nil Rate Band currently stands at £325,000 meaning that if on your death, your estate is less than £325,000, you will not pay Inheritance Tax on your estate. This begs the question “why not simply give everything away so that your estate is below the tax threshold”?
There are some gifts you can make during your lifetime which will not be taxable and can reduce your estate and so be a useful tax planning tool. However other gifts may well be caught under rules which aim to stop people giving away everything shortly before they die and so avoid Inheritance Tax.
Below is a list of lifetime gifts which are exempt under the current tax rules. This means that you won’t be charged Inheritance Tax on any gifts which fall within these.
- Gifts between a husband and wife or civil partners (UK residents) - No limit
- Gifts to charity (UK) - No limit ) You can also cut the percentage the taxman takes in Inheritance Tax if you leave at least 10% of your estate to a charity in your will.
- Annual exemption each tax year per donor - £3,000
- Small gifts to any number of persons - £250
- Wedding gifts by parents - £5,000
- remote ancestor - £2,500
- party to marriage - £2,500
- others - £1,000
- Gifts which are normal expenditure out of income - No limit
If you want to give away any other lifetime gifts that do not fall under the lifetime gift provisions above it’s important to be aware that these are still considered part of your estate if you die within 7 years of making the gift. This means, for example, that if you give your grandson or daughter £5,000 towards their mortgage and you die within 7 years of that gift that money will still be considered part of your estate. These gifts are known as “Potentially Exempt Transfers” (PETs). The value of the PET at the time it was given is taken into account and uses up your Nil Rate Band before your estate and so it turn will reduce the amount of the Nil Rate Band available to your estate, which could therefore make your estate taxable. If the value of the PET itself exceeds your Nil Rate Band then the PET will become chargeable and the tax will be paid by the person who received the gift.
Taper Relief can sometimes apply to help reduce the tax payable. Taper Relief can only be used against tax payable on a gift, not tax payable on you estate as a result of a gift using your Nil Rate Band so if your gift falls within your Nil Rate Band of £325,000 you won’t pay any Inheritance Tax on the gift itself so Taper Relief will not apply, even if the gift means that the rest of your estate has now become taxable. If the PET does become taxable then the rate of tax which applies will be subject to the Taper Relief according to the table below.
Years between gift & death
% of full charge at death rate
Not all lifetime gifts qualify as PETs so care should be taken before making any gift. Some gifts are chargeable to Inheritance Tax when they are made, regardless of how long you survive.
It is also important to consider other taxes especially Capital Gains Tax. Many gifts may well be a good idea for Inheritance Tax Planning but might well give rise to a Capital Gains Tax liability instead.
Gifts on Death
(a) Assets transferred between a husband and wife on death are exempt for Inheritance Tax purposes provided they are both live in the UK.
(b) Assets left to charities on death are exempt.
(c) Everyone has a Nil Rate Band (currently £325,000) to give away where the Inheritance Tax charge on assets within this band is 0%. The Nil Rate Band is offset against any lifetime gifts (PETs) made within the seven years before death first and if there is any balance left over it is offset against assets at the date of death.
From October 2007, where an individual dies and their spouse has died before them and not utilised all or part of their Nil Rate Band, the percentage of the Nil Rate Band unused on the estate of the first spouse to die can be transferred to the estate of the second spouse to die.
Mr White: £400,000 (House, cash & investment)
Mrs White: £400,000 (House, cash & investment)
Mr White dies first, leaving everything to his wife. There is no tax on his death because gifts between spouses are exempt:
Mr White’s assets: £400,000 (left under his will to Mrs White)
Mrs White’s assets: £400,000
Mrs White then dies leaving everything to the children:
Total Estate: £800,000
Less Nil Rate Band for Mrs White: £325,000
Less Nil Rate Band transferred from Mr White’s estate: £325,000
Tax @ 40%: £60,000
The benefit of the transferable spouse allowance is that whilst it is the percentage of the deceased spouse’s unused allowance which is transferred, it is calculated at the current Nil Rate Band rate, not the rate applicable when the spouse first died.
(d) To maximise the tax efficiency of your estate, you need to have sufficient assets belonging to each spouse which can be passed down. It may be beneficial to change the ownership of assets, but it is very important that this does not have tax or financial implications during your lifetime.
(e) Your Will needs to be tailored to your individual circumstances. Greater tax savings may be achieved where there are special types of assets, such as business or agricultural property. Some lifetime planning measures may also be recommended.
(f) If a Will has not been prepared in order to mitigate Inheritance Tax planning, the beneficiaries have the ability within two years after a person’s death to change the way the assets are dealt with. This is by a Deed of Variation. However, this scheme is subject to threat and should not be relied upon as an alternative to having a valid Will in place.
(g) Death benefits under personal pension plans or insurance policies may be subject to inheritance tax. Tax protection can be achieved by putting the polices into trust. Similarly, death benefits under an employer’s scheme can, in some cases, be subject to Inheritance Tax and a valid and up to date nomination should be put in place.
(h) Insurance policies can be taken out specifically to provide funds to pay inheritance tax. Such policies should be put in trust
Further Information and Disclaimer
The above information applies for the tax year 2014/15. Any changes to Inheritance Tax which the Government may introduce need to be reviewed carefully and may affect the rules and proposals summarised above. For the most up-to-date information and advice tailored to your personal circumstances call our Wills, Trusts and Probate Team who will be more than happy to assist. Goughs SolicitorsTel: 01225-762683 Web:www.goughs.co.uk
Disclaimer: The author accepts no responsibility for actions taken as a result of the above article. When considering legal proceedings legal advice should be sought.