The basic idea behind Inheritance Tax (IHT) is simple. When you die, the value of your estate will be assessed and if it falls over a certain threshold, HMRC will claim a share of it. In practice, however, your tax liability can depend largely on your ability to plan in advance. Here are some key pointers you should note.
IHT rates for 2021/2022
The current IHT rates are:
- Residence nil-rate band (RNRB) = £175K (for properties worth a maximum of £2M)
- Nil-rate band (NRB) = £325K
What this means in practice is that £175K of the value of your house will be discounted from the value of your estate provided that it is worth a maximum of £2M and that it is being left to a direct descendent. If your property is worth more than £2M, the RNRB is tapered off.
In addition, £325K of your remaining assets will be discounted from the value of your estate regardless of the beneficiary. For clarity, these assets can include further equity in your home. After this, your assets are taxed at a flat 40%.
It’s worth noting that there is absolutely nothing to stop this or any future government from changing these bands. In principle, the bands could be changed upward as well as downward. In practice, the cost of COVID19 suggests that the latter is far more likely.
It may therefore be advisable to take all possible steps to minimize your IHT liability so you are not relying on the government’s generosity.
You can transfer assets to a spouse free of IHT
Any transfer of assets to a spouse or civil partner is free of taxation. This includes assets passed on after death. You can also transfer the unused portion of your nil-rate bands to your spouse or civil partner.
Be aware, however, that the unused portion of your NRBs is viewed as a percentage rather than an absolute figure. For example, if you use £87.5K of your RNRB and £162.5K of your standard NRB then your spouse/civil partner would inherit 50% of each band. That means if the value of the bands changed, the value of the allowance would change too.
IHT and your home
Under current rules, if you sell your main home (residence) you are exempt from Capital Gains Tax on any profits. This means that you would not trigger CGT if you were to make a gift of your main home.
Keep in mind, however, that, for tax purposes, your gift is only valid if you give up the beneficial interest in the property. You would therefore either have to move out of the property or pay a fair-market rent to live in it.
There are, however, some possible variations on this theme. For example, you could move out of the main property and into a “granny annexe”. This could, potentially, be an astute move but it’s advisable to get proper legal advice to avoid tax complications later on.
IHT and your pension
Under current rules, pension pots are generally excluded from your estate for IHT calculation. This is not 100% guaranteed however so it’s advisable to get personal legal advice on this. Your beneficiaries may have to pay Income Tax on any money they receive from your pension fund.
IHT and your life insurance
If you write your life insurance into a trust, then it is exempted from your estate for IHT purposes. Under current rules, in general, proceeds from a life-insurance policy are exempt from income tax.
IHT and your general assets
You might wish to consider putting other assets into a trust. This would exclude them from your estate for the purposes of IHT calculations. Essentially, the assets would belong to the trust rather than you. This process can be somewhat complicated so it’s best to get legal advice.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.