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inheritance tax basics

Inheritance Tax (IHT) is a death duty tax which is levied against your assets when you die. The bill is paid by those people who inherit your assets.

Assets up to the value of £285,000 (2006/2007 tax year) are in what is known as the ‘nil band rate’ and are beyond the taxman’s clutches. All assets held in an estate beyond this mark are subject to tax at a rate of 40%.

Often the tax bill has to be paid before the estate can be released.

Inheritance Tax was originally designed to be a tax to target the wealthier members of society. The problem now is because of the increase in values of houses, more people pay inheritance tax. This is because an individuals estate includes the value of any property assets. It quite possible now that the family home can easily account for all or the bulk of the ‘nil band’ allowance for most people.

Once the value of the house is added to other parts of the estate, which may include cars, savings and investments it is quite certain that inheritance tax will affect you.

It is worth thinking now about the value of your estate and how your potential inheritance tax will be funded by the people you leave your estate to. You may also be able to take advantage of various exemptions by giving assets to friends family or other beneficiaries.

Inheritance Tax Exemptions

There are a number of key exemptions which are completely free of inheritance tax liability which can be used to pass your assets on without incurring a tax bill for your estate.

There are two main areas of exemptions, transfers between spouses and gifts to other parties.

Value of Exemptions

The ‘nil rate band’ is availble for both husband and wife (or each civil partner). The figure tends to be adjusted upwards in line with inflation each year.

Transfers between spouses are any money or assets transferred between husband and wife (or between civil partners) are exempt from inheritance tax as long as both parties are permanent UK residents.

Annual gifts of £3,000 can be given in each tax year to whoever you like, tax free.

Small gifts of up to £250 in addition to the £3,000 gift exemption can be made to as many people as you like, as long as they are not the same people who received the £3,000.

You can make gifts from income as much as you like as long as they are from surplus income, not capital, and they do not affect your standard of living otherwise the HM Revenue & Customs (MHRC) may rule that these are Potentially Exempt Transfers (PETs).

Gifts on marriage of £5,000 can be made by your parents to you, your grandparents can give you up to £2,500 and your friends can give you up to £1,000.

Gifts to charities are exempt to inheritance tax, as are gifts to some national institutions such as universities and to UK political parties.

There may be times when you want to give larger sums of money other than those listed above. It is possibe to make gifts of any size you like, but this kind of gift must be made at least seven years before the death of the donor of the gift.

Inheritance Trusts

Trusts allow you to transfer assets out of your ‘estate’ in such a way as you retain some control over them if you remain as a Trustee.

A trust is a legal relationship which is created when a person transfers assets to one or more other people or to a trust company with instructions that they hold the assets for the benefit of an individual or group of individuals.

One of the benefits of creating a trust is the separation of ownership of the trust assets. The trustees are the legal owners while the beneficiaries are entitled to the trust assets.

A Bare Trust contains savings or investments and are registered in your name but you hold them in trust on behalf of your child. Your child is treated as the beneficial owner and the savings or investments are treated as the child’s for tax purposes.

Reduce Inheritance Tax Costs by using a will.

Wills can be used to reduce Inheritance Tax liability as by dividing your estate into chunks you can potentially prevent your family from having to pay inheritance tax.

So divide your will into chunks so that none of your family have to pay over the inheritance tax threshold level.

Another good tip to reduce liability is if you are married or in a civil partnership, leave values up to the threshold level to certain people and do not automatically leave all your estate to your partner, as then when your partner dies they will have their estate and yours to divide up, and it is likely that this estate will be over the threshold of the nil band rate.

Related Sites of Interest

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