How can I save on paying Inheritance Tax?

As private client lawyers, the most frequent question we are asked is ‘how can I save on paying Inheritance Tax?’ 

Martin Lewis, the money saving expert, recently released a podcast Not the Martin Lewis Podcast – Inheritance Tax and Probate on BBC Sounds where he had three specialists in the field with him and they answered various questions from the public all surrounding Inheritance Tax (IHT). Below is a very brief and simplified summary of the topics discussed.

The key points

  • Every individual has a tax free allowance on death, called the Nil Rate Band (NRB), which is currently £325,000
  • Transfers/gifts between spouses and civil partners are exempt from IHT – the same rule does not apply to cohabitees
  • Unused allowances can be transferred to a surviving spouse
  • IHT is charged at a rate of 40% on any amount over the available allowances
  • Although most of us worry about Inheritance Tax, only around 4% of people actually have to pay any!

Residence Nil Rate Band (RNRB) and downsizing allowance

  • The RNRB is an additional IHT allowance of £175,000, given to homeowners who pass their property to direct descendants (i.e. children, grandchildren or other lineal descendants) on their death
  • If someone sells their property prior to their death, to fund care fees for example, on their death their Personal Representatives may still be able to utilise the RNRB by claiming Downsizing Allowance.
  • In order to claim the Downsizing Allowance, all of the following must apply:
    • The sale must have occurred after 8th July 2015
    • The sale proceeds must still form part of the deceased’s estate (i.e. were not given away)
    • It must be claimed within two years of the date of the deceased’s death

Transferrable Nil Rate Band (TNRB) and Transferrable Residence Nil Rate Band (TRNRB):

  • On the death of the first spouse/civil partner, provided they haven’t used all of their NRB during their lifetime and leave their entire estate to the surviving spouse/civil partner, some or all of the NRB and RNRB may be able to be transferred to the second spouse/civil partner’s estate on their death
  • There are no time limits on when this can be claimed i.e. the first spouse might have died in 2000 but their NRB can still be transferred. However, careful consideration needs to be given if the first death occurred before 1969 when there was no universal spouse exemption. 
  • The transferable allowances are calculated as a proportion of the unused allowance and not a fixed amount. There are tools and calculators available online to help determine how much can be transferred 
  • Where someone is widowed and remarries and is then widowed again, they can usually only pass on one set of transferrable allowances. 
  • However where a married couple, or one of them, have been previously widowed, then careful drafting of their Wills can mean that additional nil rate bands may be made available (potentially four separate nil rate bands)

The condition of estate property

  • If a deceased person’s property is in poor condition, the value submitted to HMRC at the date of death should reflect the state of condition. Sometimes an RICS valuation would be recommended to give a fair and honest value, taking the condition into consideration.
  • Any expenses incurred in repairing or upgrading a deceased’s property after their death may be deductible for Capital Gains Tax purposes on a sale where the property eventually sells for more than the probate value.

No cash for IHT

  • If IHT is payable on an estate, this needs to be paid within 6 months of the date of death as otherwise interest will be incurred on the amount outstanding 
  • The current rate of interest on unpaid tax is 7.75%
  • When applying for probate it is necessary to pay the proportion of the IHT on the non-property assets. In principle it is not possible to access the deceased’s funds until probate is granted
  • Most banks and building societies will allow payment of the initial IHT without probate through the ‘direct payment scheme’ 
  • Some investment companies will also liquidate stocks and shares if it for the purpose of paying IHT. This is dependent on the financial institution and will usually require the funds for tax being sent direct to HMRC
  • IHT on property can be paid in 10 equal annual instalments, the first payment being due 6 months after the date of death. The balance of the tax must be settled on the sale of the property, but until then interest will continue to accrue on the outstanding balance of IHT

Probate delays

  • It is no secret that there have been delays at the Probate Registry when applying for a grant of probate
  • The guidance issue by the Probate Registry suggests that one should wait up to 16 weeks before contacting them about a submission
  • We have been told that output at the Probate Registry is currently higher than input and this hopefully means things are heading in the right direction

How does gifting work?

  • This is something that I could spend a long time talking about so I will try and keep my summary as brief as possible
  • Every individual can give away in total £3,000 each year which is totally IHT exempt
  • If you have not used your previous years exemption, you can carry this forward for one year only. I.e. a maximum annual exemption of £6,000
  • The 7 year rule:-
    • If you make gifts in the 7 years prior to your death, they will fall back into your estate for IHT purposes
    • If the gifts total more than £325,000 (i.e. use your entire Nil Rate Band) and you die within the first 3 years of making such gifts, any part of the gift over £325,000 will be taxed at 40%, and it is the responsibility of the recipients to pay the IHT
    • If you die within 3-7 years of making the gift, the IHT payable starts to taper. However do bear in mind it is the tax on the gift that tapers, not the value of the gift itself, so taper relief is not as generous as might first appear.
  • Gifts out of surplus income:
    • If you are making gifts out of your surplus income, these will not be liable for IHT (which is a tax on capital)
    • Your executors will need to provide calculations of all your normal outgoings, including such things as your food shopping and holidays etc in order to show what you genuinely had spare income out of which to make such gifts 
    • Ideally the gifts out of income should show a regular pattern
    • Keeping clear records of your income and regular outgoings will be of enormous assistance to your Executors 
  • Gifts with Reservation of Benefit – this means where you make a gift of an asset to someone but continue to benefit from that asset. The most common example of this is parents wanting to gift their property to their children but continue living in it. If this is the case, the full property value will fall back into the parent’s estate for IHT purposes. The only way around this is for the parents to pay full market rent to live in the property. If however you have a child living with you it may be possible to gift a share of the house without there being a reservation.

What is a trust?

  • It is a flexible vehicle where assets are held by trustees for the benefit of others (beneficiaries)
  • Trustees control the assets
  • A Settlor creates and defines the terms of the trust 
  • Beneficiaries are the people who stand to benefit from the trust
  • Why create a trust? 
    • As a way of mitigating IHT, through making a gift (but as settlor you cannot benefit from your own trust)
    • Protect assets for future generations
    • Maintain a certain degree of control over assets
    • Plan appropriately for vulnerable beneficiaries 
  • Creating a trust requires careful consideration and the advice of a professional should be obtained

If any of the above is something you would like to discuss further, please contact any of the Private Wealth lawyers, who will be happy to help. We can definitely help with the question ‘How can I save on paying Inheritance Tax?’

It is also worth giving the full podcast a listen – Not the Martin Lewis Podcast – Inheritance Tax and Probate