How to avoid Inheritance Tax
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There are various ways to legitimately mitigate IHT against your estate.
Inheritance Tax (IHT) is the tax paid by our estate on our death against the value of our estate. Stick around to see how you and your loved ones might avoid gifting your hard earner money to the UK Government, after a lifetime too of income tax, VAT, and so on!
How is Inheritance Tax Calculated
The basic level of IHT is currently (Dec 2022) 40% on your net estate exceeding £325,000. This threshold is called the ‘nil rate band’. It increases periodically.
There are various exemptions and allowances which we have covered in another post here.
Who pays Inheritance Tax?
Your executors will pay any IHT due against your estate. It is a common misconception that the beneficiaries pay. They do of course indirectly in the sense that it reduces their inheritance! But, the actual payment is made from estate funds by your executors.
How do I avoid paying Inheritance Tax?
This is a minefield of technical issues, but some of the basic principles for avoiding IHT include:-
- MAKE A WILL….!
- NIL RATE BAND
- LIFETIME GIFTS (7 year rule)
- LIFETIME GIFTS (£3,000 allowance)
- LIFTIME GIFTS (gifts out of income
- GIFTS INTO TRUST
- GIFTS TO SPOUSE
- INSURANCE
Make a Will
By making a will you can not only ensure that those you want to inherit do benefit from your estate, but you can also avoid IHT. If you die without a will (called intestacy) the law decides who gets your estate – not you, and this might not be inheritance tax efficient.
Nil Rate Band
In short, in its most simplistic form, IHT planning is about making yourself as poor as you can on the day you die. In fact (see below), it is perhaps more about making yourself as poor as you can 7 years (or more) prior to the day you die!
The nil rate band is of course a moving feast as the Govt changes its amount from time to time. So, for lots of reasons, planning for this is at best exceptionally difficult. However, there are many reasons to simply ‘swallow’ IHT in any event, as making oneself as poor as possible takes away from us all sorts of security and choices.
Lifetime Gifts (7 year rule)
Gifts made in the 7 years prior to our death (over £3,000 per anum) may be taken into account as part of our estate for the purposes of the IHT due against our estate. So, survive for more than 7 years after making the gift and it will become ‘clean’ of IHT!
There is a sliding scale of IHT due for gifts made in the 7 year ‘countdown’ period.
IHT mitigation really involves making yourself as poor as you can when you die!
Lifetime Gifts (£3,000 allowance)
Even in the 7 years prior to death, there is an annual allowance for us all of £3,000 per anum in total. This is against us an individual – NOT £3,000 per ‘beneficiary’.
Lifetime Gifts (gifts out of income)
Similar in spirit to the £3,000 allowance, gifts out of income allow us to make gifts during our lifetime even in the 7 years prior to our death. Whether something is form excess income is a question of fact for your executors to prove with the revenue when any IHT calculations are made during probate. In short, the idea is that your executors must prove that the gifts came from income that was not in any way needed by you during your lifetime for any other purpose.
Gifts into Trust
A much over estimated tool by many (not least some unqualified Will Writers – as opposed to specialist wills solicitors), writing things into trust during your lifetime ‘can’ sometimes have the effect of taking it outside of your estate for IHT purposes. It is a minefield – for lots of reasons, not least the rules surrounding ‘gifts with reservation of benefit’ or GROBs.
Gifts to Spouse
Gifts to surviving spouses are free of IHT irrespective of the amounts involved.
Gifts to Charities
Similarly to the spouse exemption, gifts to registered charities are also free of tax irrespective of the amounts involved.
Insuring against IHT
There are financial products designed to assist with Inheritance Tax Planning. You should seek expert financial advice on this and any other IHT planning issues. This post is intended as a generic overview of some of the basic principles of IHT – it is NOT intended to be specific legal or financial advice.
Why should I pay Inheritance Tax (IHT)?
The above may all seem lovely and routes through to a penalty free, IHT free life (or death)! But it is NOT that simple.
As above, the basic principle of IHT planning is to make yourself as poor as you can 7 years to the day (or more) before you die. In doing so, we perhaps compromise ourselves during our lifetimes in a way that may be unattractive. Wealth gives us (in part at least) choices and security – over medical and residential care, sudden financial needs, and so on. By gifting (in some form or other) that hard earned wealth away simply to reduce IHT, we may place ourselves in an uncertain situation. So beware! And, perhaps consider – is it a price worth paying.
What are Gifts with Reservation of Benefit (GROBs)?
This is a gift that you make but do so without cutting all ties. So for example, you might purport to gift your home to your children but continue to live there. In doing so, you have ‘retained’ the benefit of that asset and so on your death the Revenue would seek to take into account its full capital value for IHT – despite your apparent gift.
In fact, that example is overcome by paying your children a commercial rent. HOWEVER, gifting the home that you live in is a step fraught with huge risk and one which you should only consider doing having taken specific and expert legal advice.
Can I avoid paying Inheritance Tax?
So, what does the above tell us about mitigating or avoiding IHT altogether? In its most simplistic form it tells us that mitigating or avoiding IHT is about making ourselves as poor as we can 7 years prior to our death. It tells us that doing that requires us to make any gifts outright, and to not fall foul of the gifts with reservation of benefit trap. And, it perhaps therefore also tells us that Inheritance mitigation is not a ‘penalty free’ easy thing to achieve.
Specialist Online Wills Solicitors
If you would like advice from our expert wills and estate planning solicitors on any of the issues raised in this post – do reach out! You can email us at wills@qlaw.co.uk or call 03300 020 365.
Hi
My father recently passed away and my mother is struggling to cope with the size of her property. However, if she downsizes, what is the situation with regard to inheritance tax? Her current property would be valued at approximately £350k which would equal her IHT property allowance when combined with my father’s, but the new property may be over £100k less. Is there a way she could still benefit from the full £350k allowance, otherwise she risks falling into the grasps of IHT with regard to the rest of her estate, having too much cash after liquidating some property value.
Another consideration is that she was either going to complete a deed of variation to redirect the non-joint part of my father’s estate (the residual estate) to myself and my sister, or take the estate herself as named beneficiary and then gift us the equivalent (to potentially benefit from reducing IHT due to taper relief if applicable, although she is 80 years old). However, she may now need to use those funds in the short term to fund a cash purchase of a new property. Even though a deed of variation has 2 years to be completed, and I believe can still be used even after finds have already been distributed, if my mother used the funds to purchase property, and replaced them once her old property was sold, would a deed of variation still be effective in passing the funds to myself and my sister as if from my father’s estate, despite having being claimed and used temporarily by my mother?
Many thanks
A really interesting question for which thank you. This discussion forum isnt intended to be taken as legal asdvice, but hopefully the following points around the subject matter may help! And, if you would like to talk to one of our estate planning lawyers – you can always do so!
So, you have quite rightly highlighted some key areas:
1) Transferrable nil rate band
2) Residence nil rate band
3) Deeds of variation; and
4) Lifetime gifting and the Taper Relief that goes with that.
How they apply to the combined estates will of course be down to
1 & 2 – nil rate bands
These are what they are and it is simply a case of applying the relevant rules/thresholds. All estates will attract a nil rate band currently £325k, and a further £175 residence nil rate band can apply too where property is passing to direct descendants. This creates an effective total nil rate of £1mil. If the nil rate bands go unused on first death (of a married couple), then they can be used on the death of the survivor – hence the £1mil total. However, the nil rate bands MUST be
unused
3) Yes, the general rule for deeds of variation is indeed 2 years. The obvious snag that appears however is that if the variation diverts gifts away from spouse (who is an exempt beneficiary by virtue of the spouse exemption) to a chargeable beneficiary, it then ‘uses’ up some or all of the nil rate band(s) removing them from the potential to be used on second death.
4) And, that is where lifetime gifting becomes an option (it is for your mother to decide of course on whether it is the correct option for her!). As you rightly say, a gift made by your mother would set the 7 year rule ‘ticking’ during which Taper Relief potentially applies. If the person making such a gift survives 7 years then that gift falls out of the estate. And, if the nil rate band on first death remained in tact (unused), that can also be claimed (on current rules) too.
If you have not already seen them, you may find the following blogs helpful:
Lifetime Gifting
Gifts with Reservation of Benefit
Deeds of Variation
Thank you again for reaching out. This forum is not intended to be legal advice, but if you do need help, thats where our expert solicitors come in! So, please don’t hesitate to make contact if you would like advice.
Thank you for your reply. Just a query on the deed of variation issue if I may… I understand that it would permanently reduce the IHT allowance available to pass from my father to my mother if a deed of variation was to be used instead of my mother gifting the funds from her receipt of the residuary estate. However, my primary concern is whether a deed of variation can still be applied to my father’s estate if my mother has in the interim accepted the funds as beneficiary and used them temporarily to part fund a property purchase. If she thereafter replaced the funds by selling her original property (quicker and easier to move into new property before preparing original one for sale), would a deed of transfer still be effective so that her subsequent transfer of the value of my father’s residual estate to myself and my sister would be successfully treated as if we had been originally named as beneficiaries in my father’s will and would not be treated simply as a gift from my mother?
Many thanks for taking the time to respond.
Thanks so much for your further question! Deeds of variation are very often entered into after the ‘initial beneficiary’ has received funds from the estate.
(Please remember that this forum is NOT legal advice and should not be taken as such)