Inheritance tax (IHT) is a tax payable on the estate of someone who has died, and is usually levied on the value of all the assets within an estate – such as money and property – after deducting any liabilities, exemptions and reliefs.
IHT is payable by the beneficiaries of the estate, and for this reason, effective estate planning is important, as the amount of IHT you are eventually subject to could impact the amount of money you are able to pass on your loved ones.
There are lots of estate planning options you can consider to mitigate any potential IHT liability, and pass on your assets to the next generation in the most effective way, such as using allowances or making gifts.
IHT is usually charged at 40% of any part of your estate that exceeds your personal allowance, also known as the nil-rate band. The nil-rate band is currently £325,000 for the 2021/22 tax year, and will remain fixed at this amount until April 2026.
Surviving spouses can inherit the unused nil rate band of a deceased spouse.
As well as the nil-rate band, the Residence Nil Rate Band (RNRB) was introduced in April 2017. This extra allowance applies when a residential property is left to children or grandchildren, so long as the individual has resided in the property at some point during their lifetime.
The RNRB is £175,000 for the 2021/22 tax year and could potentially save an individual up to £70,000 in tax, or up to £140,000 for a married couple.
IHT planning options
You can give away gifts of up to £3,000 each year which is not subject to IHT. This limit increases to £6,000 if the previous year’s annual allowance has not been used. A small gifts allowance also allows you to make IHT exempt gifts to any number of people per year, which is limited to £250 per recipient. Regular payments out of your income, with no set limit, that do not affect your standard of lifestyle are also exempt from IHT. It is important to note that when someone is making lifetime gifts, other tax charges such as CGT or SDLT may be charged.
Watch our video below where Private Client Tax Manager Harriet Pye-Watson explains more about lifetime gifting. This video is part of our wider Inheritance Tax planning video series, which can be viewed on our YouTube channel.
Potentially exempt transfers (PETs)
PETs are gifts to individuals, and transfers into certain types of trust, which exceed the available exemptions. Whilst there is no IHT to pay when the gift is made, if you die with seven years of making the gift, and the value of the PET exceeds the nil rate band, IHT will be payable.
Assets can be transferred out of your estate into a trust, which can reduce your IHT bill, and allow you to maintain control over who receives the benefits, when they receive them and how they are used.
Your pension can be a valuable tool for estate planning as your pension is outside your estate and consequently exempt from IHT. A pension can potentially be used to give your beneficiaries a tax-free income if you die before the age of 75. If you die after 75 the money would be taxed as income when it is withdrawn. You could potentially save IHT by leaving your pension untouched and funding your retirement with other assets, such as investments, that do form part of your estate.
Watch our video below where Chartered Financial Planner Mufaddal Travadi, from our group company Smith Cooper Independent Financial Solutions, explains more about pension planning. This video is part of our wider Inheritance Tax planning video series, which can be viewed on our YouTube channel.
How we can help
Inheritance tax planning is a complex area with lots of rules, exemptions and reliefs, and getting the balance right between reducing your IHT liability and ensuring you have sufficient assets to plan for different eventualities can be tricky.
Our dedicated private client team specialise in IHT planning, and are well equipped to devise a planning strategy that meets your individual requirements.