Inheritance Tax (IHT) is levied on estates valued over £325,000 and where it’s due, it is paid at a rate of 40 percent. This figure was chosen to ensure only wealthy families paid the tax but it has remained unchanged since 2009 and has been frozen until at least 2026.
Unfortunately, this means that as inflation continues to rise, more families will be subject to IHT. Rising house prices are also set to force more people to face IHT charges and Richard Bate, a partner at Weightmans LLP, commented on this worrying trend.
“Sharply rising house prices across the UK – which are on average already 13 percent higher than before the pandemic, according to research by Nationwide – have created something of a perfect storm on the inheritance tax front,” he told Express.co.uk.
“As house prices increase, so too will the value of your estate – which could see you exceed the nil rate band, or push more of your estate than anticipated above the threshold.
“This is already the case for many households. Figures from HM Revenue & Customs reveal a 35 percent year-on-year increase in the number of people seeing their taxable estate rise above the threshold, which equates to a £0.7billion uptick in tax charges in just 12 months.”
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How to reduce the size of your estate for Inheritance Tax
Mr Bate explained the nil rate band allowance may vary depending on individual circumstances. This includes whether a person is a widow or widower, or if they are eligible for the Residence Nil Rate Band.
The Residence Nil Rate Band was introduced in 2017 to protect against rising house prices, and is currently capped at £175,000. It is designed to deliver savings where property is left directly to either children or grandchildren – for estates up to a maximum value of £2million.
While there is little one can do to slow down rising house prices, Mr Bate provided guidance on how people can reduce the size of their estate and limit the impact of IHT.
“In any event, while it’s obviously not possible to slash the value of your house, there are other steps you can take to reduce the size of your estate, either to reduce the amount that sits above the threshold, or help you stay below it completely,” he said.
“The nil rate band of £325,000, and the additional £175,000 Residence Nil Rate Band, are transferable between spouses and registered civil partners, leaving a surviving spouse or registered civil partner with a maximum possible threshold of £1million.
“However, this does create a disproportionately detrimental impact on those whose estates exceed £2million, but also on unmarried couples, and those without children. The nil rate band remains frozen even as house prices rise. We would urge the Government to consider reforms to ensure IHT rules are equal and fair.”
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Gifts and Potentially Exempt Transfers
On top of transferring assets between partners, people can also gift money away which in turn will reduce the liability. Britons are entitled to gift up to £3,000 each tax year without them being added to the value of their estate, in what is known as an annual exemption.
It is also possible to carry any unused exemption forward to the next year. Additionally, surplus income can be given away, so long as this is done regularly. Mr Bate acknowledged this may “seem like a drop in the ocean” compared to the overall value of an estate, but over the years it can make a significant difference.
He concluded: “Another option is a Potentially Exempt Transfer (or PET) – a gift of an unlimited amount that will become exempt from IHT if you survive the gift for a period of seven years. If you were concerned that the intended recipient was not yet ready to handle such a gift, you may consider leaving money in trust instead – just make sure any tax charges associated with the trust are also carefully considered. If a trust is used, the maximum amount that can be given away without an upfront tax charge is £325,000 within a seven-year period.
“Our recommendation would be to seek bespoke advice for your estate planning, to help you make the most informed decision about how to construct your will, how to effectively make use of trusts and gifts to protect as much of your inheritance as possible.”
“Gifts gone wrong”
While taking advantage of gifts can be beneficial for IHT, recent analysis from Boodle Hatfield showed how detrimental it can be when they go wrong. According to research from the firm, taxpayers paid £125million in unnecessary tax through “gifts gone wrong” in the past year.
Boodle Hatfield said the most common example of this is parents gifting the family home to their children but continuing to live there. This makes them so-called “Gifts with Reservation of Benefit” – assets which have been gifted to another person but are still being used by the original owner.
These assets are considered by the taxman to remain part of the donor’s estate for IHT purposes. As a consequence, those who have been gifted the assets could face a considerable tax bill.
According to its analysis, 440 people made the mistake of falling into the Gifts with Reservation of Benefit trap in the last year alone. Boodle Hatfield warned given recent increases in property values, HMRC is likely to be examining IHT returns closely to ensure the right amount of tax has been paid and that gifts of property, that have been made to mitigate IHT, have been executed properly.
With this in mind, Boodle Hatfield said people who are planning to pass on assets need to take the “seven-year rule” into consideration. Assets may be gifted without incurring IHT provided the donor survives for at least seven years after making the gift.
Geoffrey Todd, Partner at Boodle Hatfield, commented: “Hundreds of people are being unnecessarily caught out each year when passing assets along to the next generation.
“On average, they are throwing away more than a quarter of a million pounds each by falling into an avoidable trap.
“The complexity of the IHT regime means it’s very easy to make mistakes. Unfortunately, this can lead to beneficiaries facing hefty bills, so it’s crucial to seek professional advice before including the family home in one’s estate planning.”