The new tax year marks the one-year countdown to most defined contribution pensions becoming part of your estate for inheritance tax (IHT) purposes. It’s a move that will mean more people paying IHT.
Now it’s important to say that even with the changes the vast majority still won’t be facing a bill, but if you’re one that will, we’re looking at ways to help manage it.
This article isn’t personal advice. Tax rules can change, and any benefits depend on your circumstances. If you're not sure what's right for you, ask for financial advice.
How much can I leave free from inheritance tax?
Recent data shows that by the start of the next decade just over 9% of estates will face an IHT bill. And there’s a few different reasons for this.
IHT is only normally payable if your overall estate is worth more than £325,000. This is your nil rate band. If you’re planning to pass on your family home to a direct descendant – a child or grandchild for instance – then you have a further nil rate band called the residence nil rate band, worth up to £175,000.
So, a single parent passing down their family home to their child could pass on up to £500,000 without the estate facing an IHT bill.
If you’re married or in a civil partnership, there are even more advantages.
To start with, you can pass on assets of any value to your spouse/civil partner IHT free. But they also inherit any unused nil rate bands you have. So, a surviving spouse/civil partner can potentially pass on up to £1mn before the estate faces an IHT bill.
There’s a word of warning here for cohabiting couples – you don’t enjoy the same advantages as a married couple so will not inherit each other’s nil rate bands or assets IHT free. This can come as a nasty shock at what’s already a difficult time. So take the time to plan for this and make sure important documents like wills and expression of wish forms for pensions are updated and maintained.
How can I lower my inheritance tax bill?
For those who think their loved ones might face an IHT bill, it’s important to say there are things that can be done to manage it.
One option might be to start gifting assets while you’re still alive instead of waiting to leave them to someone after you’re gone. Giving them away while you’re alive also means you can help people reach their financial goals that bit sooner.
But the important thing is to make sure your own needs will continue to be met. Don’t run the risk of giving away too much too soon and potentially leaving yourself short of money later in life.
What are my gifting allowances?
For those considering gifting there are various allowances that you can make use of. To start with, any amount of money you gift to a loved one will fall out of your estate for IHT purposes after seven years. These are known as Potentially Exempt Transfers (PET). If you die within that time, IHT may need to be paid – though potentially at a reduced rate.
There are also allowances that will take money out of your estate immediately. For instance, your £3,000 annual gifting allowance, which can also be carried forward into the next year if unused (but you can’t go any further back than that).
You can also gift up to £250 to any number of recipients, but not to someone you have also made a gift to using another allowance. Doing this would mean part of the gift is classed as a PET and you’d have to live another 7 years before it becomes IHT-free.
There are also allowances that can be used when a loved one gets married. You can give up to £5,000 to a child, £2,500 to grandchildren and great grandchildren and £1,000 to anyone else. These gifts need to be made on or before the wedding – and the wedding does need to go ahead.
Another important exemption is what’s known as gifting out of surplus income. You can give away any amount (although see below), and it comes out of your estate for IHT purposes immediately.
But there are conditions that need to be met for this exemption to apply.
The gifts need to come from income, not capital. They generally need to be made on a regular basis, and they must not affect your standard of living.
An example of this could be paying school fees for a grandchild. It’s a handy rule but as with all gifting you must make careful notes so that your executors can demonstrate the gifts have met these criteria if they’re asked about it later. It’s a good idea to get help from a financial adviser to make sure you stay on the right side of the rules.
Gifts to charities and political parties can also be made IHT free.
On death, if you gift at least 10% of your net estate to a UK registered charity, the rate of IHT on your remaining estate will drop.
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