Estate Planning

Inheritance tax (IHT) is a tax payable on a person’s estate (their money, property and other assets) when they die. Lifetime IHT charges may arise if a person puts assets into a trust above a certain value.

Inheritance tax isn’t payable when you pass your estate to a husband, wife or civil partner, or to charity, when you die. Otherwise, IHT is only payable when your estate (including the value of your undrawn pension) is worth more than £325,000. There is an additional allowance of up to £175,000 if you leave your home to your children or grandchildren (if you have them). The allowances can be transferred between spouses and civil partners. This means that on the death of the second partner there could be a total tax-free allowance of £1m. The standard IHT rate is 40% and only charged on the part of your estate that’s above the combined allowances.

Inheritance tax is payable on the net value of a person’s estate. Their executor — the person who deals with the estate — will pay it from the assets within the estate. Any inheritance tax due on your pension will be paid by the pension provider directly to HMRC.

IHT isn’t usually charged on the beneficiaries of an estate. People who have received a gift during the lifetime of the person who has died may have to pay IHT but only if the person who makes the gift gives away more than £325,000 and dies within seven years of making the gift.

Assets that you gift to your spouse — whether on death or in your lifetime — will pass free of inheritance tax.

Thanks to Business Relief, inheritance tax on business assets can be reduced or even eliminated under certain conditions. 

The business must be a trading business, not an investment company. A similar relief called Agricultural Relief can apply to farm property. 

It’s important to plan ahead to ensure that your business assets qualify for business relief and the relief isn’t wasted when considering business succession. Recent changes to the taxation of business interests will mean many now having to find tax that wouldn’t previously.

Planning for inheritance tax can involve several strategies to legally minimise the amount of tax due on your estate, including having an up-to-date Will, making use of allowances and exemptions, lifetime gifting and trusts. The specifics of IHT can be complex, and vary depending on personal circumstances, so it’s strongly advisable to seek professional advice.

Our team contains STEP (Society of Trust and Estate Practitioners) qualified specialists in dealing with inheritance tax who can assist with calculating your potential IHT liability and advise on ways to mitigate it. We help executors with calculating IHT when someone has died, as well as calculating IHT on trusts.

The rules are the same for civil partners as for married couples, so you don’t have to pay inheritance tax (IHT) when you leave assets to each other on death or in your lifetime.

Lifetime gifts to individuals are treated as potentially exempt transfers (PETs), which means that there’s no immediate charge to inheritance tax when the gift is made. 

PETs are ‘potentially’ exempt because if the donor (the person making the gift or deemed to be making the gift) survives for seven years from the date of the gift, the gift becomes fully exempt from IHT. 

If the donor fails to survive for seven years, the gift becomes chargeable and will use up (all or part of) the donor's nil rate band (currently £325,000 or up to £650,000 if they’re a surviving spouse or civil partner). 

For any amount over the nil rate band, the longer the donor survives after making the gift (subject to surviving at least three years), the lower the IHT. This relief is called ‘taper relief’. 

It should be noted (and this is commonly misunderstood) that taper relief only reduces the amount of tax payable on a failed PET. It doesn’t reduce the ‘value’ of the PET itself.

There’s no limit on the amount that you can gift to others during your lifetime. However, it should be borne in mind that a person’s available nil rate band of £325,000 will be used up by any such gift. Therefore, if you make a gift of £1m and die within seven years of making that gift, £675,000 will be liable to IHT at 40% and will be payable by the recipient of the gift. This rate will be ‘tapered’ if you survive for more than three years. 

Generally, when assessing your IHT exposure after you’ve died, your executors will look at all the gifts you’ve made in the seven years prior to your death.

While you’re able to gift all or part of your home to your children, there are some risks that you should bear in mind.

Gifting your property to your children means that you’re in effect relinquishing legal ownership. This can put you in a vulnerable position — particularly if you intend to stay at the property — if your children decide to exercise their legal right to sell the property and evict you. 

If your child is bankrupt or going through a divorce, the property may be used as part of a settlement or to pay off debts.

Additionally, if you gift all or part of your home but continue to live in it, this may fall within the ‘Gift with a Reservation of Benefit’ (GROB) regime, which can have serious tax consequences on your death.

If you give a property away and continue to enjoy the benefit of it, although you’re not the legal owner and may not enjoy legal rights in relation to it, HMRC doesn’t consider that you’ve fully given the property away for inheritance tax (IHT) purposes. 

In fact, on your death HMRC will treat the value of the item gifted as though it’s part of your estate, even though you don’t own it. 

For example, if you gift your house to your children with the view that it’ll reduce the size of your estate for IHT purposes but continue to live in the house, even though you don’t own it the value of the house will be counted towards your estate for IHT and your estate could pay up to 40% tax on this. 

While there are ways in which this risk can be avoided and HMRC does have some leeway and exceptions, given the potential risk you should seek expert legal advice before arranging such a gift.

Gifts to individuals out of excess income generally have no immediate tax consequences.

If a gift is made out of spare income and the following conditions are satisfied, the gifts shouldn’t be taken into account for inheritance tax purposes if you die within seven years.

While the gifts must be made out of available income, you must still be left with enough income to maintain your usual standard of living. HMRC’s assessment of ‘your usual standard of living’ is specific to you (not a universal standard).

The gift must be ‘normal’, meaning that it’s habitual or typical for the specific donor (the person making the gift). This will usually be apparent where there’s a pattern of gift-giving, though this isn’t always required. However, the requirement for gifts to be typical does rule out gifts for a specific purpose (such as a wedding gift). 

In most cases, there should be a discernible pattern of gift-giving over a reasonable span of time (HMRC prefers for this to be around three to four years).

HMRC will also consider a range of factors in assessing the above conditions, including the frequency of gifts, amount of each gift (and how they compare to each other), nature of the gifts, who the recipient is and what the reasons for the gifts are.

If a lifetime gift becomes liable to inheritance tax because the donor (the person making the gift or deemed to be making the gift) dies within seven years of making the gift, the IHT payable will be the liability of the recipient of that gift — though this will depend on the terms of the deceased’s Will. If you’re considering making gifts and are worried about this, you may wish you to review and amend your Will. 

The Residence Nil Rate Band is an additional inheritance tax-free allowance of up to £175,000 introduced in 2017. It applies to estates where the death occurred after 6 April 2017 and the deceased owned an interest in a property that’s ‘closely inherited’ by a lineal descendant. 

The definition of a lineal descendant includes children, grandchildren, great-grandchildren, a spouse of a lineal descendant and step children. The definition doesn’t include other descendants such as nieces and nephews or the children of an unmarried cohabitee.

If the value of an estate exceeds £2m, a taper is applied and the relief is reduced by £1 for every £2 that the value exceeds £2m. So, by the time a person’s individual estate exceeds £2.35m, there’ll be no RNRB left to apply. 

Married couples whose combined estates exceed £2m but whose individual estates don’t exceed £2m may be able to take steps to ensure that one RNRB can be claimed on the first spouse’s death, which could provide a tax saving of up to £70,000. 

When someone dies and leaves everything to their spouse, the value of their estate is exempt from inheritance tax because of the spousal exemption, so their Residence Nil Rate Band goes unused. 

Much like the main nil rate band, the executors of widows and widowers can claim any unused RNRB from their deceased spouse or civil partner, even if the first death occurred prior to 6 April 2017. It’s important to note that the RNRB can only be transferred between spouses and civil partners, not cohabitees. 

To qualify for the Residence Nil Rate Band, you must own or have owned an interest in an eligible property. An eligible property isn’t limited to bricks and mortar and can include dwellings such a static caravan or even a houseboat if it can be demonstrated that this was in fact your home. To do this, you must have lived in that property at some point during your lifetime. 

The Residence Nil Rate Band isn’t limited to the property that you live in at the time when you die. However, for the property to qualify for relief, you must have lived in it at some point during your lifetime. A property that you own but have never lived in — such as a buy-to-let property — isn’t a residence and is therefore ineligible for the RNRB.

Where a property has been sold prior to someone’s death and either a new property hasn’t been purchased because they have moved into permanent residential care or a smaller, less valuable property has been purchased in its place, it may be possible to claim a downsizing addition to make up for the amount of Residence Nil Rate Band that has been lost.

The downsizing addition is available where:

• the person sold, gave away or downsized to a less valuable home on or after 8 July 2015
• the former home would have qualified for the RNRB if the person had kept it until they died
• the person’s direct descendants inherit at least some of the estate.