Inheritance tax (IHT) becomes an issue when someone dies. It is a one-off tax paid on the value of the deceased's estate above a set threshold – currently £325,000.
The tax is set at 40% of any value over that threshold, reduced to 36% if more than 10% of the estate is given to charity. To work out how much IHT, if any, needs to be paid, the executors of the estate need to add up the value of all of the assets, then subtract any debts, bills and funeral expenses.
There are lots of ways to reduce the amount of IHT your family will pay after you have gone.
If you are married or have a civil partner, he or she can inherit your entire estate without facing any IHT bill. So if your half of the house is worth £200,000 and you have another £200,000 in assets of any other kind, the whole lot can go to your spouse or civil partner without a charge.
He or she also inherits any part of your IHT allowance not used on your death. So if you left them everything, they can now leave up to £650,000 without any tax being payable. But if, for example, you left £150,000 to other family members, he or she can only leave up to £500,000 before there is any IHT to pay.
The allowance from the first partner to die is transferred to the second partner only after the second partner's death. There are further details and links to the relevant forms here .
Rather than wait until you are dead to pass on your assets, you might decide to dispose of some of them while you are still alive. There are lots of gifts you can make which can reduce the value of your estate.
You can hand over as much as you want, to anyone you want, in the form of "potentially exempt transfers". As their name suggests, these are only potentially exempt from IHT. Under the rules, if you live for seven years after making them they are exempt; if you die within seven years they will be added to your estate and, if the estate is worth over £325,000, the gift will attract some IHT:
• Within three years – the full amount of IHT is due
• Within three to four years – 80% of the IHT is due
• Within four to five years – 60% of the IHT is due
• Within five to six years – 40% of the IHT is due
• Within six to seven years – 20% of the IHT is due
This is worth bearing in mind if you are giving away a large sum of money to help someone with a purchase, like a house. You need to think about whether there is enough money to foot the IHT bill in more liquid assets so your offspring does not end up having to sell the property to pay the tax.
also give away up to £3,000 in each tax year without it being included in your estate when you die. That annual allowance can be carried forward to the next tax year, allowing you to give away up to £6,000 in one year.
There are other gifts which are completely exempt, however quickly after making them you die. These are:
• Gifts to your spouse or civil partner
• Gifts to charity and some other organisations, including musuems and amateur sports clubs
• Gifts of up to £250 a year to as many people as you want
When a couple marries, people are allowed to give them the following without the money being included in the giver's estate (the gift has to be made, or promised, near the date of the wedding or civil partnership):
• Parents can give them cash or gifts worth up to £5,000
• Grandparents can each give up to £2,500
• Anyone else can give up to £1,000
The gifts outlined above can help reduce your bill, but there are other things which will not have an impact.
You cannot, for example, give away your property to your children and continue to live there free of charge to avoid the tax. If you give away the property and move out, it will become exempt after seven years; but if you give away the property and live there, you will be expected to pay a market rent – and the owner will need to pay income tax on that rent. Otherwise, the property will be considered a "gift with reservation of benefit" and may still be subject to IHT.
A good financial adviser should be able to help you organise your cash in a way that will mean your relatives do not end up paying more IHT than they need to after you have gone.
The tax owed on an estate is calculated by the executors of the will. They must include all of the assets – including relevant gifts made within the last seven years – when they do their sums.
It is their responsibility to pay what is owed within six months of the end of the month in which the person died.
Raising the money to pay the bill may mean cashing in any savings accounts held by the deceased, and/or selling some of the assets in the estate. If money is tied up in property you can arrange for the IHT to be paid in monthly instalments over 10 years – however, there will be interest to pay on top of the IHT.
If you are keen to reduce what needs to be sold, you could consider taking out a life insurance policy to cover it. You will need to have the policy written "under trust" or it will be added to your estate and your relatives will end up paying IHT on the pay out. Speak to a financial adviser or insurer to find out how to do this.