Inheritance Tax – Introduction

What is Inheritance Tax and how to reduce the bill?

Inheritance Tax is usually paid on an estate when somebody dies. It’s also sometimes payable on trusts or gifts made during someone’s lifetime. Some trusts also have further charges to Inheritance Tax during the life of the trust.  Most estates don’t have to pay Inheritance Tax because they’re valued at less than the threshold (frozen at £325,000 since 2009). The tax is payable at 40 per cent on the amount over this threshold or 36 per cent if the estate qualifies for a reduced rate as a result of a charitable donation.

Increased threshold for married couples and Civil Partners

Since October 2007, married couples and registered Civil Partners can effectively increase the threshold on their estate when the second partner dies – to as much as £650,000. Their executors or personal representatives must transfer the first spouse or Civil Partner’s unused Inheritance Tax threshold or ‘nil rate band’ to the second spouse or Civil Partner when they die.

The new tax allowance on the home

From April 2017 a new tax allowance has been introduced on the home – often termed the Residential Nil Rate Band.  This starts at £100,000 from 2017 increasing £25,000pa until it reaches £175,000 in 2020.  From then on it should have increased in line with inflation based on the Consumer Prices Index but it is now frozen at the 2020 level until 2025/26.  Like the personal threshold any allowance unused on first death can be transferred to the surviving spouse/Civil Partner and used on their subsequent death.  Complex rules apply so please refer to other pages for further information.

How can you reduce the IHT bill?

As part of any estate planning exercise, you may ask us to undertake for you, we offer our clients several solutions to reduce the Inheritance Tax bill on your Estate which invariably involve the use of trusts.

Trusts can be set up either in your lifetime or on your death (i.e. via your Will).

Lifetime trusts can be used in the following cases:

• lifetime tax planning (e.g. you want to make a gift to reduce your own taxable estate but would prefer to control the asset/funds rather than making an outright gift to your beneficiary);
• accepting assets from your estate on your death (i.e. directed into them via your Will), for example, business assets or a portion of or even the whole of your estate; and
• keeping the proceeds of any life policies or death in service benefits out of your and your family’s taxable estates.

Trust provisions can also be written into your Will and are therefore not set up until your death.

Note that not all trusts are effective for Inheritance Tax so the correct type of trust must be created.

Out three key trusts for mitigation of Inheritance Tax are:

1. the Nil Rate Band Trust, a Will trust which allows you to take maximum benefit of the tax-free allowances⁽¹⁾ already available to you;
2. the Business Property Relief Trust which enables you to fully protect your business assets and AIM share portfolio from Inheritance Tax; and
3. the Family Trust which is a lifetime trust and can be utilised in all the scenarios described above.

Note (1) From October 2007 new rules have been introduced relating to the Transferable Nil Rate Band for married couples and civil partners. However, there are still many reasons for drafting tax-efficient Wills using trusts despite this concession.

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