1. Maximise the Nil-Rate Bands
The Standard Nil Rate Band is the threshold above which Inheritance Tax (IHT) is paid. The Nil Rate Band is currently £325,000 and has been fixed at this amount for the last 10 years. This means that the first £325,000 of your belongings, property and cash can be gifted free of Inheritance Tax. Anything over this amount is taxed at 40%.
If the threshold has not been fully used when the first person in a marriage or civil partnership dies, then that unused part can go to the surviving husband, wife or civil partner when they die. The basic tax-free threshold available when a wife, husband or civil partner dies can be as much as £650,000 if none of the £325,000 threshold was used when the first of the couple died.
The percentage of the threshold that was not used when the first partner died increases the basic threshold that’s available to their estate .
A man dies leaving legacies totalling £600,000. He leaves £130,000 to his children and the rest to his wife. The available threshold at the time was £325,000.
The legacies to the children would use up 40% (£130,000 ÷ £325,000 x 100) of the threshold, leaving 60% unused.
When his wife dies, the threshold is still £325,000. Their available threshold would increase by the unused percentage (60%) to £520,000.
If his wife’s estate is not worth more than £520,000 there’ll be no Inheritance Tax to pay when she dies. Inheritance Tax would be payable on anything above £520,000.
The Residence Nil Rate Band was introduced in 2007, which effectively means that married couples or those in a civil partnership can gift £1m before Inheritance Tax becomes payable, more details can be found in our blog post entitled Nil Rate Bands - Can I Reach the Magic £Million?.
2. Use your Annual Exemptions
Each year you are allowed to make gifts which are exempt from IHT. Over time, you can use these exempt gifts to move substantial sums out of your estate and as such reduce any IHT liability. Any gift exceeding your annual allowance will be treated as a Potentially Exempt Transfer (PET) and you will need to survive for 7 years for it to be excluded for IHT purposes. If there’s Inheritance Tax to pay, it’s charged at 40% on gifts given in the 3 years before you die. Gifts made 3 to 7 years before your death are taxed on a sliding scale known as ‘taper relief’. You can read more in our blog post entitled Inheritance Tax considerations you should take into account when Writing a Will.
3. Give Gifts to Exempt Beneficiaries
Gifts made to certain people and organisations can be completely exempt from IHT, these would include:
A spouse or civil partner
Qualifying UK or EU charities
Qualifying Political Parties
Some National Institutions such as universities, museums and the National Trust.
4. Own Exempt Assets
Certain types of assets can be passed free of IHT or at a reduced rate. This would include assets such as business assets, woodland, farmland and National Heritage Property. If you're married or in a civil partnership, then you could give your non-exempt assets to your spouse or partner and your exempt assets to non-exempt beneficiaries, such as your children, this will mean that your non-exempt assets become exempt because gifts to your spouse or civil partner are free from IHT.
5. Inherit Money Tax Efficiently
If you are to inherit money, then this may push your estate over the Nil Rate Band. If you don't need the money then you can sign your gift over to a chosen beneficiary. This action is called generation skipping and is a good option if you don't really need the inheritance.
Many people do not realise that a Will can be altered following the death of the testator but if the beneficiaries are all adults (i.e. over the age of 18) and they all agree, then they are permitted to change a Will and even the rules of intestacy. This has to be in writing and is known as a Deed of Variation, an Instrument of Variation or a Family Arrangement. Often these types of deeds are used to improve the tax planning or to make provision for another beneficiary. For example:
A beneficiary may wish to redirect their entitlement to other members of the family who are less well provided for; or
To save tax, often Inheritance Tax especially if the deceased's Nil Rate Band and any exemptions and reliefs have not been fully utilised. Or to decrease the effective rate to 36% (from 40%) if more than 10% of the estate is being left to charity.
The deed has to be entered into within 2 years following the death of the testator and must be drafted by a qualified professional. Where a minor beneficiary's interest is to be varied, then court approval may be required, and irrespective of this a minor's share cannot be decreased, it must either stay the same or increase in value. Once entered into, the Deed is final and irrevocable and so it is vital that it is correct since you do not have a second bite of the cherry, especially where the intention was to save Tax and a mistake has arisen.
A beneficiary can disclaim their gift, i.e. they refuse it. The Law does not compel a person to accept a gift and refusing it is known as a disclaimer. The beneficiary must refuse the gift before accepting any benefit from it and it will pass to the next person entitled under the Will or then Rules of Intestacy. The beneficiary disclaiming their gift cannot specify where they would want it to go and so a Deed of Variation is often preferred since these are more flexible. Again, the disclaimer must be in writing and within 2 years of the death of the testator.
Following the Budget in July 2015, the HMRC carried out a consultation on the use of deeds of variation for tax purposes. It concluded that there was no evidence of abuse, although they would continue to monitor their use.