Most people do not want to give money to the taxman when they die. However, while it is said that inheritance tax (IHT) is a voluntary tax that can be avoided by giving away money during your lifetime, there is the practical issue that people need money to live on while they are alive. This is compounded by the fact that most people do not know when they are going to die, making planning with any certainty difficult.
Despite these limitations, there are some simple steps which can be taken to allow money to be given away IHT-free.
Nil rate band
Everyone has a nil rate band – set at £325,000 and remaining at this level until at least 5 April 2028. Any unused portion of the nil rate band can be used by the deceased’s spouse or civil partner’s estate on their death. There is no IHT on gifts sheltered by the nil rate band.
Residence nil rate band
A separate nil rate band applies where a main residence is left to a direct descendant, such as a child or grandchild. This is set at £175,000. However, it is reduced by £1 for every £2 by which the deceased’s estate exceeds £2 million (so not available where the value of the estate is at least £2.35 million). As with the standard nil rate band, any unused portion can be claimed by the estate of the deceased’s spouse or civil partner.
Gifts from income
The gifts from income exemption is a very useful exemption. It allows an individual who does not need all their income to make regular gifts of that income free of IHT, rather than simply letting it accumulate in a bank account and attracting a potential IHT charge if passed on when the individual dies.
There are conditions. The gift must be made regularly and must leave the individual with enough to meet their outgoings. The gifts must be made from income rather than depleting the individual’s capital.
This exemption could be used by a parent to help a child with their rent or mortgage payments – here it is usually advisable to set up a regular standing order. Alternatively, a grandparent can pay a grandchild’s school fees.
There is no IHT to pay on anything left to a spouse or civil partner. The ability to transfer any unused nil rate band eliminates worries about leaving the surviving spouse or civil partner provided with sufficient funds for the remainder of their life while passing on the estate in a tax-efficient manner. Both parties’ nil rate bands can be used when the estate is passed on following the death of the surviving spouse/civil partner.
There are a number of small exemptions that can be useful. The first is the annual exemption set at £3,000 a year. Where it is not used one year, it can be carried forward to the next year and used once the exemption for that year has been used. Over 20 years, this exemption allows £60,000 to be given away IHT-free, saving IHT of up to £24,000.
There is also a specific exemption for wedding gifts – set at £5,000 for a gift to a child, £2,500 for a gift to a grandchild and £1,000 for other wedding gifts. There is also an exemption for small gifts of up to £250 per person (as long as they have not benefitted from another IHT-free gift, such as a wedding gift).
Gifts made at least seven years before death fall out of account for IHT purposes. Where the gift is made at least three years before death, a taper applies. Making early lifetime gifts can save IHT, but the donor cannot continue to benefit.
Trusts can be effective at saving IHT; however, consideration of trusts is outside the scope of this article. Professional advice should be sought.