7 ways to save on inheritance tax

It used to be that inheritance tax was considered a death tax which only impacted those who were very wealthy. These days, with the high property prices in the last decade there are increasingly more ordinary families that get affected by the 40% inheritance tax on all assets inherited from their loved ones.

In the past five years, the value of properties that exceed the inheritance tax threshold nearly doubled in the past 5 years, average prices for detached houses in London, the South East and South West are already worth more than £300,000. Due to this, even those who don’t have a lot of cash or other assets but own a home that is worth more than the threshold, find themselves struggling to sell their home to drop the value of their estate below the IHT threshold.

If you are looking to reduce tax liability on any inheritance that you might receive from your parents or if you’re concerned about how much tax your heirs may end up paying, then the following tips will help you take the necessary steps to make savings on inheritance tax.

1)    The nil-rate band

The nil-rate band or inheritance tax threshold is £325,000 at the moment. This means that you can leave up to that amount to your family or friend without having to pay inheritance tax, anything above that limit is taxed at 40%. The nil-rate band applies to the amount of money that is left to your beneficiaries. For any amounts or assets that are passed between spouses or civil partners there is no inheritance tax to pay, regardless of the amount transferred.

A recent legislation also states that married couples and registered civil partners can also inherit each others’ unused amounts of the nil-rate band upon the death of one of the couple. This means that the joint nil-rate band is worth £650,000.

So if for example a husband dies, then his unused individual allowance can be transferred to his wife. This makes it simpler because when one spouse dies than any of their possessions and share of the home automatically transfers to the surviving spouse. When the second spouse dies, provided that the first spouse didn’t use their allowance, then the inheritance tax would only be due on the estate if its value exceeds £650,000.

2)    Write your will or review an existing one to make sure its up-to-date

When someone dies without a will, he or she is considered to have died intestate and the government will make the decision regarding who inherits your money and assets. While intestate rules in England & Wales are complex, in majority cases most of your estate will go to your spouse or civil partner, if none exist then your children, if none exist then to your blood relatives.

The size of your estate will determine the effect of intestacy rules. For large estates (those worth over £250,000 if there are children, or £450,000 if there are none), the spouse may receive less than you expect, so it is always advisable to have a will instead of having to be reliant on the rules of intestacy.

As an example, having a will would enable you to transfer some of your assets to children, grandchildren or others after you die, within the nil-rate band which would make the gifts free of IHT.

Always remember to update your will after any major life change such as an addition to the family, the death of your spouse or a divorce.

3)    Giving away your property

The following exemptions exist for those wishing to save inheritance tax:

Up to £3,000 can be given away each year without having to pay inheritance tax, the unused portion from the previous year’s exemption can also be carried forward. This means that any couple that hasn’t used their last year’s allowance can give away a total of £12,000 in the current year. The amount can only be carried over for one year.

Up to £250 can be given to any individual without paying inheritance tax, this can be used for example, as birthday and Christmas gifts from grandparents to grandchildren

Up to £5,000 can be given as a wedding gift, tax free, from a parent to a child. Grandparents can give each grandchild £2,500 and anyone else can gift the newly-wed with £1,000. The gift must be given shortly before marriage, as it is only exempt from IHT if the marriage takes place.

If for example, your daughter is getting married and you and your spouse wish to gift her with money to pay for a deposit on a house, you could potentially gift her with £22,000 in a year. This total works out from the combined allowances for the current and previous year (£6,000 + £6,000) plus the two wedding gifts of £5,000 each.

4)    Giving away extra income

In case you have surplus income year on year, then you have the option of giving it away without having to pay inheritance tax. You will however need to be able to prove that the gifts are part of your regular annual expenses and that they don’t affect your standard of living. This surplus can be used to pay life insurance premiums to the benefit of someone else.

It is recommended to keep a record of such gifts, as well as the record of your net income (after tax). This is a very useful exemption since there is no upper limit, which is why it would be wise to keep the documentation safe.

5)    Potentially Exempt Transfer (PET)

Prior to death, you can give away cash or property free of tax, provided that you survive for seven years after the transfer.

After three years, your heir may receive some tax relief which may increase each year up until the seven years run out. However, if the gift’s value is less that the nil-rate band, then the amount is put back into the entire estate which is then evaluated for inheritance tax liability.

Be warned that you cannot avoid inheritance tax by giving away your home but still continuing to live in it, free of rent. Under such circumstances, the tax authorities would still consider the house as part of your estate. Your home can still be given to your child if they live with you, provided that they live in the property until your death or if you move into a care home, and you both have to  contribute to the maintenance of the house.

6)    Relief for business property

Some types of businesses and business assets may be eligible for 100% exemption from inheritance tax after two years. This relief is usually applicable to a business or a business interest, or to shares in an unlisted company. Shares that are quoted on the Alternative Investment Market also qualify after holding them for 2 years. It is best to speak to your business accountant or financial adviser if you think that you are eligible for such relief.

7)    Charitable donations

Charities, political parties (as long as they have at least one Member of Parliament and 150,000 votes), registered housing associations and some national institutions can be gifted tax-free.