What is Inheritance Tax?

Inheritance Tax is a tax that many people do not consider and presume it is something only the rich and elderly need to be concerned about. This is no longer the case. Many ordinary working families are now affected by the tax.

Inheritance Tax is charged after a person’s death on all their assets, typically their home and savings, over a specified amount, currently £325,000 (tax year 2010/11). If you add up the value of your house, savings, investments, life insurance policies and other assets, you may be surprised how much you are worth.

The main reason for the increase in the number of families facing an Inheritance Tax liability is the dramatic increase in house prices in recent years. With the decline in house prices the number of families affected will be reduced but it remains a very large number.

How is it Calculated?

You are allowed to leave money, investments, property and any other assets up to a total value of £325,000 this tax year (2010/11) before having to pay Inheritance Tax. This is called the 'nil rate band.'

If the value of all your assets after deducting liabilities, such as your mortgage, is more than £325,000 then you potentially face an Inheritance Tax bill in the event of your death.

Above this threshold, tax is charged at 40%. So, if your personal assets were £400,000 Inheritance Tax would be charged on the top £75,000, 40% of which is £30,000. The threshold usually rises every tax year (April 6 to April 5) roughly in line with inflation.

Tax Calculator

Please use our quick calculator to see if you have a potential Inheritance Tax bill.

Assets				Less Liabilities
Value of House:		£		Outstanding Mortgage:		£
Other Property:		£		Overdraft:		£
Personal Chattels:		£		Other Loans:		£
Bank Accounts:		£		Credit Card Debts:		£
Investments:		£		Miscellaneous:		£
Stocks, Shares & Bonds:		£
Savings Plans:		£
Life Assurance Policies:		£
Pension Benefits:		£
Other Assets:		£

Results

(This calculation will give a rough estimate of your potential Inheritance Tax liability only).

Please note:

No Inheritance Tax is paid on transfers to a surviving spouse. This rule was augmented by Inheritance Tax spouse relief introduced with immediate effect on 9th October 2007. This relaxed the usage of the nil rate band for Inheritance Tax between spouses (and to same sex couples who have registered their civil partnership). Previously, when a surviving spouse died only their own nil rate band of £325,000 was available. A couple now shares a joint nil-rate band of £650,000 so that any relief not used when the first spouse dies is available to the surviving spouse. For further information on Inheritance Tax spouse relief, please click here (PDF file help).

Donations to UK registered Charities are exempt.

Account must be taken of certain gifts made in the seven years before a person dies. Not all gifts in this seven year period have to be included. All gifts between spouses are exempt as are a single gift of £3,000 each year, any number of smaller gifts of £250, £5,000 to a child getting married and finally gifts that can be called normal habitual expenditure (which means that they are made out of income not capital).

Furthermore, if you give away an asset in your life time but reserve an interest in it, then the value of the asset must be included in the calculation. This is the case even if the gift was made more than seven years before you die (this usually happens when a person gives their house to their children but continues to live there until their death. Here, the value of the house will need to be included for the purposes of Inheritance Tax).

For more information on Inheritance Tax, please go to www.direct.gov.uk

For further information on whether you have a potential Inheritance Tax liability, please go to www.hmrc.gov.uk

Inheritance Tax Checklist

For a full Inheritance Tax checklist, please click here (PDF file help).

Ways to Reduce the Liability

“Inheritance Tax is a voluntary tax, paid by those who distrust their heirs more than they dislike the Inland Revenue.” Lord Jenkins (Liberal Democrat and Labour politician).

The good news is that there are financial planning options available to reduce your Inheritance Tax liability or exempt you altogether. Some of the options are fairly simple while others can include more complex schemes including gifts to family members or setting up trusts.

You must give thought to your specific circumstances. The often used example is the situation where parents make over assets to a child in a rocky marriage which subsequently ends in divorce. The estranged spouse-in-law makes off with half the assets originally made over by the parents.

The most important ways to reduce your potential liability are as follows:

1. Make a Will

The most essential advice in the context of reducing the liability is that you must make a Will. You should then review this Will on a regular basis and update it as and when your circumstances change. This will allow you to set in place an ongoing structure to ensure that no more Inheritance Tax is paid than is absolutely necessary.

2. Take full advantage of the spouse exemption and spouse relief

Assets left to a spouse are not taxed. In addition, the new spouse relief introduced in October 2007 made the individual Inheritance Tax thresholds transferable between spouses. This allows a couple to combine their individual allowances thereby making the first £650,000 of an estate tax free.

A simple example would be as follows: Tom decides to use £25,000 of his £325,000 Inheritance Tax allowance to leave assets tax free to his children. He leaves the rest of his assets to his wife Caroline. Tom subsequently dies. Caroline inherits the assets left to her tax free because of the spouse exemption. Furthermore, following the introduction of spouse relief, she inherits the balance of Tom’s Inheritance Tax allowance thereby allowing her to potentially leave a total of £625,000 without incurring a tax charge.

3. Make full use of allowances

You should give away as much as you can in your lifetime. These unlimited transfers (known as potentially exempt transfers ‘PETs’) are fully exempt from Inheritance Tax provided that you survive for seven years after making the transfer. There is some relief if death occurs in the seven year period.

As mentioned in the section on how to calculate Inheritance tax, you are also entitled to give away up to £3,000 tax free each year. If this annual exemption allowance is not fully utilised, it can be carried forward to the following tax year. Likewise, full use should be made of the unlimited number of £250 gifts and gifts out of normal, habitual expenditure.

4. Avoid retaining beneficial interests

If you transfer an asset, such as a house, it is essential that you do not retain a beneficial interest. If an interest is retained, the gifted asset (known as a gift with reservation) is still treated as part of your estate for Inheritance Tax purposes.

Newly introduced legislation has stopped the use of sophisticated schemes, such as life interests and double trusts, to avoid the gift with reservation rules. If you have one of these schemes in place, you should take professional advice in considering the alternative options now available to you as the legislation is retrospective.

5. Make use of trusts

You may also want to consider using a specialised trust such as a Discretionary Will Trust to mitigate your potential tax liability. A trust is a legal arrangement that allows you to give away assets such as money, property or shares in a tax efficient manner and on terms determined by you to beneficiaries chosen by you.

The actual mechanics of setting up a trust are fairly complex and it is important to ensure that any trust is tailor made to suit your specific needs.

Professional Advice

If you think you might have a potential Inheritance Tax liability, you should consider consulting a Solicitor or Accountant who specialises in tax planning. Inheritance Tax planning is usually a complex and long term affair and ongoing professional advice will be essential.

If you live in England or Wales, to find a Solicitor who specialises in Inheritance Tax planning in your area please click here. To find an Accountant who specialises in Inheritance Tax planning, please click here.

If you live in Scotland, to find a Solicitor who specialises in Inheritance Tax planning in your area please
click here. To find an Accountant who specialises in Inheritance Tax planning, please click here.

If you live in Northern Ireland, to find a Solicitor who specialises in Inheritance Tax planning in your area please click here. To find an Accountant who specialises in Inheritance Tax planning, you should contact the Institute of Chartered Accountants in Ireland at ca@icai.ie



Please note that information which we provide through Lasting Post is in outline for information or educational purposes only.  The information is not a substitute for the professional judgment of a Solicitor, Accountant or other professional adviser.  We cannot guarantee that information provided by Lasting Post will meet your individual needs, as this will very much depend on your individual circumstances. You should therefore use the information only as a starting point for your enquiries.