How to plan your presents with an eye on the future
Benjamin Franklin said: “Nothing is certain in life except death and taxes”. However unjust you consider income tax to be, there’s more in store as inheritance tax (IHT) could be payable when you die. This means your hard-earned savings and lifetime investments — on which income tax has already been paid — could be subject to further tax after your death.
The earliest death duty levied by the government dates back to 1694 and in 1796 a tax on estates was introduced to help fund the war against Napoleon. Around 100 years later this was replaced by a more ‘modern’ estate duty charged on the capital value of land, and IHT as we know it was introduced in 1986. IHT is payable on the value of your taxable estate when you die. But in calculating your taxable estate there are two main exemptions without limit — sums left to a spouse or civil partner and legacies to UK registered charities. Assets left to non-exempt beneficiaries are free of tax up to the IHT threshold, currently £325,000 per person and the remaining assets are charged at 40 per cent. However, this rate can be reduced when ten per cent or more of the net estate passes to charity, invoking an IHT rate 36 per cent.
In the case of a husband and wife, therefore, no IHT is payable on the first death. However, provided that the £325,000 tax-free threshold hasn’t been disposed of by the deceased by will or by lifetime gifts within the seven years prior to death, it may be transferred to the surviving spouse, resulting in the IHT threshold increasing to £650,000 on the second death.
In 2017 the government introduced a further top-up to the IHT threshold by way of a ‘residence nil-rate band’. Where residential property belonging to the deceased passes to lineal descendants, children or grandchildren, a potential additional £175,000 each (£350,000 per couple) is available which could, in some cases, bring the IHT threshold to £1 million per couple. There are certain criteria to be met, and the government has set a cap on the value of assets of £2 million, above which the exemption tapers — and is wiped away when assets exceed £2.25 million.
IHT is payable on the value of your estate when you die. A key way of avoiding the tax is to give assets away during your life. But beware! Lifetime gifts made within seven years of death, to anyone other than your spouse or a charity, will normally become taxable.
Furthermore, lifetime gifts from which you retain a benefit will not be regarded by HMRC as gifts at all. A common scenario may be a parent gifting their home to a child but continuing to live in it. As long as you continue to benefit from the asset gifted, HMRC will still treat it as your asset for IHT purposes. A possible way around this problem is, having gifted the property to children or any other non-exempt beneficiary, to rent it from them at a market rate. However, this is generally not a popular option.
There are several other ways of making gifts during your lifetime that won’t attract IHT. For instance, £3,000 per year can be given to individuals without the seven-year rule applying. Gifts can be made out of regular income but must be surplus to what you require and should form a regular pattern as opposed to a oneoff payment. Gifts to political parties are IHT-friendly for those who are inclined to make use of this exemption — although in my experience not too many people opt for this! National heritage assets, both land and objects, can also be gifted without fear of IHT.
It is important to consider both the IHT consequences and the lifetime tax planning opportunities when writing your will. With the benefit of proper advice and planning of lifetime financial affairs and will-related matters, it should be possible to reduce the IHT bill or in some cases wipe it out completely. This will ensure assets that would otherwise go to the tax man are given to your beneficiaries instead.
Lifetime gifts from which you retain a benefit are not seen as gifts
Carolyn Addleman is director of legacies, KKL Executor & Trustee Co. KKL Executor and Trustee Company Ltd is the legacy arm of JNF UK. 020 8732 6101, enquiries@ kkl.org.uk