Every person has an Inheritance Tax (IHT) threshold of £325,000. This is known as the Nil Rate Band. Only assets in excess of this threshold are liable to IHT, such tax calculated at a rate of 40%. So on an estate worth £400,000, after the deduction of the Nil Rate Band the sum of £75,000 (i.e. £400,000 – £325,000) is liable to IHT giving rise to an IHT liability of £30,000 (i.e. £75,000 x 40%).
However, there are a number of ways of reducing or perhaps even eliminating altogether your liability to IHT.
Firstly, you can consider lifetime gifts to your family and friends. Using the same example of an estate worth £400,000, in theory you could make an immediate gift of say £100,000, thereby reducing the value of your estate to £300,000. However, this is not an overnight remedy as you need to survive the date of the gift by seven years before it falls outside of your estate for IHT purposes. If, therefore, you made a gift of £100,000, your allowance of £325,000 would be reduced by the same amount (i.e. to £225,000) until 7 years elapse whereupon your allowance will be reinstated in full.
Annual Gift Allowance
A further and much used IHT tax planning tool is utilising your annual gift allowance of £3,000. Making annual gifts up to but not exceeding this amount will not impact on your allowance of £325,000. You are also able to rollover the previous tax year’s allowance (only one year) such that you could make an immediate gift of £6,000 (this year’s allowance plus last year’s). If you followed a programme of gifts of say over a ten year period, you could dispose £33,000 of your estate thereby making a saving of £13,200 in IHT (i.e. £33,000 x 40%).
You are also able to make small gifts of £250 each year to any number of people without it impacting on your allowance, provided they are not the same recipient as the subject of the £3,000. Each person can only receive one small gift per year and unlike the £3,000 annual exemption it does not partly exempt a larger gift and it cannot be carried forward to the following year.
A much underused exemption is gifts out of surplus income. If your income exceeds expenditure it is open to you to pay your surplus income to your family without it affecting your IHT allowance. It is important, however, that you keep careful records of your income, expenditure, and gifts out of surplus income so when your estate is administered and the IHT position assessed, your executors can demonstrate that this aspect of your tax planning did not adversely affect your normal standard of living – otherwise the value of the gifts can be brought back into account for IHT assessment purposes.