If your estate is worth more than the Inheritance Tax threshold (£325,000 individual personal allowance or £650,000 for married couples/civil partners for the 2016-17 tax year) there are some important Inheritance Tax exemptions that allow you to make gifts to others and not have to pay tax on them when you die.
Exempt beneficiaries or 'donees'
You can make gifts to certain people and organisations without having to pay any Inheritance Tax, without having to write a Will. These gifts are exempt whether you make them during your life or as part of your will.
You can make exempt gifts to:
- your husband, wife or civil partner, as long as they have a permanent home in the UK
- a 'qualifying' charity established in the EU or another specified country
- some national institutions such as museums, universities and the National Trust
- any UK political party that has at least two members elected to the House of Commons or has one elected member but the party received at least 150,000 votes
Gifts that you give to your unmarried partner, or a partner that you're not in a registered civil partnership with, are not exempt. When making a Will in Bristol seek advice on gifting and the tax implications.
You can give away gifts worth up to £3,000 in total in each tax year and these gifts will be exempt from Inheritance Tax when you die. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don't use it in that year, the carried-over exemption expires.
In addition to the annual exemption there are other exemptions for certain types of gifts.
Some gifts made during your lifetime are exempt from Inheritance Tax because of the type of gift or the reason for making it.
- Wedding gifts/civil partnership ceremony gifts
- Wedding or civil partnership ceremony gifts are exempt from Inheritance Tax, subject to certain limits:
- parents can each give cash or gifts worth £5,000
- grandparents and great grandparents can each give cash or gifts worth £2,500
- anyone else can give cash or gifts worth £1,000
You have to make the gift - or promise to make it - on or shortly before the date of the wedding or civil partnership ceremony. If the ceremony is called off and you still make the gift - or if you make the gift after the ceremony without having promised it first - this exemption won't apply.
You can make small gifts up to the value of £250 to as many individuals as you like in any one tax year. However, you can’t give more than £250 and claim that the first £250 is a small gift. If you give an amount greater than £250 the exemption is lost altogether. You also can’t use your small gifts allowance together with any other exemption when giving to the same person.
Regular gifts or payments that are part of your normal expenditure
Any regular gifts you make out of your after-tax income, not including your capital, are exempt from Inheritance Tax. These gifts will only qualify if you have enough income left after making them to maintain your normal lifestyle.
- monthly or other regular payments to someone
- regular gifts for Christmas and birthdays, or wedding/civil partnership anniversaries
- regular premiums on a life insurance policy - for you or someone else
You can also make exempt maintenance payments to:
- your husband, wife or civil partner
- your ex-spouse or former civil partner
- relatives who are dependent on you because of old age or infirmity
- your children, including adopted children and step-children, who are under 18 or in full-time education. This includes education or training of your children.
The seven-year rule - 'potentially exempt transfers'
Any gifts you make to individuals will be exempt from Inheritance Tax as long as you live for seven years after making the gift. These sorts of gifts are known as 'potentially exempt transfers'. However, if you give an asset away at any time, but keep an interest in it - for example you give your house away but continue to live in it rent-free - this gift will not be a potentially exempt transfer.
If you die within seven years and the total value of gifts you made is less than the Inheritance Tax threshold, then the value of the gifts is added to your estate and any tax due is paid out of the estate. However, if you die within seven years of making a gift and the gift is valued at more than the Inheritance Tax threshold, Inheritance Tax will need to be paid on its value, either by the person receiving the gift or by the representatives of the estate.
If you die between three and seven years after making a gift, and the total value of gifts that you made is over the threshold, any Inheritance Tax due on the gift is reduced on a sliding scale. This is known as Taper Relief.
This is how taper relief can reduce tax due on PETs:
- If the gift was made less than three years before death, no reduction in tax is due
- If the gift was made three to four years before death, tax is reduced by 20%
- If the gift was made four to five years before death, tax is reduced by 40%
- If the gift was made five to six years before death, tax is reduced by 60%
- If the gift was made six to seven years before death, tax is reduced by 80%
Gifts into trust
Gifts into trust are not generally exempt from Inheritance Tax. Trusts have to be disclosed to HM Revenue & Customs (HMRC). Will writing and including a Trust is dealt with in a very similar way and Rose & Trust of Bristol can help in this process,
What is a transfer into trust?
The person who puts assets into a trust is known as a 'settlor'. A transfer of assets into a trust can include buildings, land or money and can be either of the following:
- a gift made during a person's life
- a transfer or transaction that reduces the value of the settlor's estate (for example an asset is sold to trustees at less than its market value) - the loss to the person's estate is considered a gift or transfer
Working out if Inheritance Tax is due
For most types of trust Inheritance Tax is due when you make transfers that total more than the Inheritance Tax threshold. You work this out by adding up the value of any transfers (based on the loss in value to the settlor's estate) and any chargeable gifts made in the previous seven years by the settlor. Inheritance Tax is due on everything above the threshold.
If the trustees pay, the rate of tax is 20 per cent. If the settlor pays the Inheritance Tax instead of the trustee, this means there will be an increased loss from the settlor's estate. The amount of tax due will therefore increase. These calculations are complex.
Death within seven years of making a transfer
If you die within seven years of making a transfer into a trust your estate will have to pay Inheritance Tax at the full amount of 40 per cent. This is instead of the reduced amount of 20 per cent which is payable when the payment is made during your lifetime. In this case your personal representative - who manages your estate when you die - will have to pay a further 20 per cent out of your estate based on the value of the original transfer.
If no Inheritance Tax was due when you made the transfer, the value of the transfer is added to your estate when working out whether any Inheritance Tax is due.
If you continue to benefit from a gift in a trust
If you make a gift into any type of trust but continue to benefit from the gift - for example, you give away your house but continue to live in it - you will pay 20 per cent on the transfer and the gift will still count as part of your estate. These are known as gifts 'with reservation of benefit'.
This creates a situation where there are two possible Inheritance Tax charges if you die:
- a charge when you transfer the gift into a trust
- a charge to your estate when you die - because the asset is still considered part of your estate
To avoid double taxation, only the higher of these charges is applied - in other words you won't ever pay more than 40 per cent Inheritance Tax.
Gifts into a trust for someone who is disabled
You don't have to pay Inheritance Tax immediately if you make a gift to a trust for someone who is disabled. Inheritance Tax may still be due when you die.
The money you release can be passed onto your heirs and, providing you survive the gift by seven years, there will be no tax to pay. Of course you can also always spend it on yourself.
Put life insurance policies under trust
If you have life insurance that you specifically want to be paid to your heirs after your death, then always put the policy under trust. Policies under trust don’t count towards your estate when the IHT bill has to be worked out. They can also be paid out before probate is granted, and can therefore get money quickly into the hands of your beneficiaries.
Deed of variation
A deed of variation allows your heirs to alter your will after death so that, for example, part of the inheritance is re-directed to someone else. They can draw up a deed of variation within two years of your death, but all beneficiaries under the will must agree to the variation.
Take out an insurance policy
If you can’t beat an IHT bill, you can insure against it. This is one of the simplest ways of covering an unwelcome bill, but unless you are relatively young and healthy, the cost may be high.
How does it work?
You take out an insurance policy called a ‘whole of life’ policy. If you are a couple, you should normally take out a policy that pays out when the second partner dies. The policy is written under trust for your heirs (see above). The insurance company will provide the trust form. The idea is to take out a policy that will pay out enough to cover the IHT bill. Because the policy is written under trust, it is paid out free of inheritance tax and before probate is granted, so your heirs can pay the tax bill as soon as it’s due.
HMRC treats the premiums paid to the insurance policy as a lifetime gift if you pay them yourself, but these can usually be covered by one of the tax-free exemptions – either the annual £3000 exemption or the ‘gifts out of normal income’ exemption.