Inheritance Tax Changes: Could they Work for You?

The Government has ordered a sweeping review of Inheritance Tax and whether it causes any distortions to tax payers’ decisions. Laura Colville, Associate Solicitor in the Wills and Probate team thinks the simple answer to this is yes. She outlines what could change and ways you could maximise gifting to minimise the tax burden in the future.

Inheritance Tax (IHT) is widely regarded by families and tax experts alike as a regime that has been unchanged for almost 40 years that is both unfair and over-complex. Other countries, including the USA, have scaled back this unpopular tax and it now seems that the Chancellor, Phillip Hammond, may think the time is now right too. He has asked for proposals for simplification, 'to ensure that the system is fit for purpose and makes the experience of those who interact with it as smooth as possible'.

Officials from the Office of Tax Simplification are set to probe everything from submitting returns and paying tax, to making IHT-free gifts and estate planning - but there is no indication of whether the 40 per cent IHT rate or the threshold will be cut, or increased.

Currently, everyone can bequeath £325,000 before IHT is payable. This amount can be doubled if each spouse or registered civil partner uses their allowances. In theory, a married couple or civil partners will be able to pass on an estate worth £1million including their home from 2020. 

The review could see the introduction of radical changes, charging IHT on the person who receives the inheritance rather than the estate of the deceased.  You could have a tax free allowance based on their relationship to the person making the gift. 

For example, a parent could make gifts of up to £250,000 per child during their lifetime or on death, a grandchild could receive £50,000, a niece or nephew £25,000, or anyone else £15,000. The recipient would then pay tax on anything above these limits.

Possible Gift Allowance Increase

HM Revenue & Customs allows you to make a number of small gifts each year without creating an IHT liability. You can also make larger gifts, but these are known as ‘Potentially Exempt Transfers’ (PETs), and you could have to pay IHT on their value if you die within seven years of making them.

The estate doesn’t pay IHT on up to £3,000 worth of gifts given away by the deceased in each tax year (6 April to 5 April). This is called the ‘annual exemption’. Leftover annual exemption can be carried over from each tax year to the next, but the maximum exemption is £6,000.

The estate may not have to pay IHT on assets the deceased gave away as gifts while they were alive.

A gift can be:

• Anything that has a value, for example, money, property, possessions
• A loss in value when something’s transferred, for example, if a parent sells a house to a child for less than it’s worth, the difference in value counts as a gift

There’s no IHT payable on any gift married couples or registered civil partners give each other – as long as they live in the UK permanently.

The Office for Tax Simplification review of IHT is widely expected to address anomalies around the "gifting allowance", which has remained unchanged since 1981.

This figure has not changed for over 30 years, and if it had increased with inflation it would be around £9,500. Raising the threshold of the Gifting Allowance opens up more thoughts on how you could go some way to mitigate the IHT burden on your next generation.  

Use your more flexible pension pot

Recent pension freedoms allowing you to take your retirement savings when you turn 55 could be a useful way to fund your grandchildren’s (or your children’s) education or help them with a deposit on a property.

Taking some of your tax-free cash – you can usually take 25% of your pension savings this way – to pay some or all of their costs means you get to see them benefit from an education without the heavy burden of student debt sitting on their shoulders.

With fees, accommodation and living expenses for a three-year course typically costing £67,000 according to the National Union of Students, studying at university doesn’t come cheap.

A word of caution here: Using your pension savings could set them up for life but you need to carefully consider your own retirement needs.  Remember that your pension post is free from IHT and making a gift from it could bring that money into the IHT calculation upon death. Advice should be taken from your Independent Financial Advisor before you make any decisions.

Seven-year rule

Taper relief applies where tax, or additional tax, becomes payable on your death in respect of gifts made during your lifetime. The relief works on a sliding scale. The relief is given against the amount of tax you’d have to pay rather than the value of the gift itself. The value of the gift is set when it’s given, not at the time of death.

The original owner must live for seven years after giving the gift. If they don’t, their estate or the person who received it will have to pay IHT on it.

The amount due is reduced on a sliding scale if the gift was given away between three and seven years before the person died.

Gifts you don’t pay Inheritance Tax on

Wedding gifts

Given on or shortly before the wedding date or registered civil partnership ceremony, gifts up to:

• £5,000 to a child
• £2,500 to a grandchild or great-grandchild
• £1,000 to anyone else

Individual Gifts up to £250, not in the same tax year
Regular gifts from the giver’s income

Assuming the deceased had enough money to maintain their normal lifestyle, these include:

• Christmas, birthday and wedding or registered civil partnership anniversary presents
• Life insurance policy premiums
• Regular payments into ISAs or other Savings account

Payments to help with living costs

These include payments to:

• An ex-husband, ex-wife or former registered civil partner
• A relative who’s dependent on them because of old age, illness or disability
• A child (including adopted and stepchild) under 18 years old or in full-time education

Gifts to Charities, clubs, museums or universities
Political parties

Use a Trust

Many grandparents intend to leave some money to their grandchildren in their Will but if you want them to benefit while you’re still around, using a trust to give them surplus income or capital could help them meet those university or property costs.

As a trustee, you retain an element of control over the funds and how and when they are paid, while gifts made to the trust can reduce your estate for IHT.

Using a discretionary trust gives grandparents the greatest flexibility and control but the taxation is higher and more complex.

Untangle the Complexity

IHT is a very complex area of financial planning. Even with the Government’s call for simplification, there are sure to remain exceptions and every person and their family’s circumstance is unique. It is therefore essential to get expert advice and pay less tax that you need to on the estate that you pass on.  

Laura Colville is an Associate Solicitor, based at our Chichester Office. She advises on all aspects of Wills, Probate, Trusts & Tax Planning and Estate Administration. Laura is a fully accredited member of Solicitors for the Elderly and also a Dementia Friend. For a discussion with Laura about your individual circumstances,  please contact her on 01243 787899 or email ljc@andersonrowntree.co.uk