Inheritance Tax  

A ‘notoriously tricky tax’: How to minimise liability for IHT

This article is part of
Intergenerational wealth planning (Part I)

A ‘notoriously tricky tax’: How to minimise liability for IHT

With millennials expected to inherit trillions of pounds over the next two decades, how much of the net worth that is often tied up in parents’ and grandparents’ pensions and properties will be passed on, and passed on tax-efficiently?

When someone dies, the value of their estate becomes liable for inheritance tax. This is paid by the estate of someone who has died if its total value exceeds a set threshold called the nil rate band, which is £325,000 for an individual. 

This limit can be different, say, when a home is being passed to children or grandchildren, or where the threshold is combined with that of a spouse or civil partner.

As things stand, gifts made within seven years of a client’s death, and even some gifts, such as those made to trusts or companies, may also be added to the total value of the donor’s estate and, if the total value exceeds the threshold, potentially taxed at a reduced rate.

However, there are exemptions to this rule: gifts valued at less than £250 individually, totalling less than £3,000 a year or to help with certain people’s living costs are exempt from IHT.

Key points

  • The nil rate band for inheritance tax for an individual is £325,000
  • UK domiciled spouses and civil partners can transfer their whole estate to each other with no liability to inheritance tax
  • Anyone who looks likely to be liable to pay the tax should start planning as early as possible

But now that pensions, in some form or another, can be passed onto the next generation, and the fact that house prices have skyrocketed over the past decade or so, IHT planning has become more crucial than ever. 

The level of IHT thresholds are such that it does not take much for many people to be caught by them. 

So what exactly are the liabilities and when should planning start?

Know the rules

It is important to remember that IHT is chargeable at a rate of 40 per cent of the excess of an individual’s estate over the nil-rate band, says Tracy Crookes, financial planner at Quilter Private Client Advisers.

She explains: “UK domiciled spouses and civil partners can transfer their whole estate to each other with no liability to inheritance tax but, on second death, a liability could arise depending on the value of the estate at that time. 

“However, where the surviving spouse/civil partner is non-UK domiciled, the transfer is not unlimited but restricted to £325,000 – or the IHT nil-rate band at the time if this changes.”

She adds: “As all individuals have a nil-rate band of £325,000, this means transfers to a non-UK domiciled spouse are [IHT] free where the estate is valued at £650,000 or less and any excess is chargeable at 40 per cent under the normal rules.”

According to Laura Suter, personal finance analyst at AJ Bell, IHT is a “notoriously tricky tax to navigate and understand”.

For example, she points to recent research by HM Revenue & Customs, which found that just 45 per cent of people giving money actually knew how inheritance tax rules worked.