Your guide to the New Inheritance Tax rules
Understanding the new Inheritance Tax rules
Inheritance Tax has often been assumed to apply only to the very rich.
In recent years however, the freezing of the existing tax free threshold has meant that more and more people living in the UK have become liable. According to data from HMRC, in the 2016/17 tax year around £4.8 billion was collected in Inheritance Tax – far more than previously.
In April 2017, the laws around Inheritance Tax changed, with a new allowance being brought in to enable people to pass on more of their estate to their direct descendants. A person’s estate, which includes all assets such as investments, cash savings, cars, art or additional property – becomes potentially liable for 40% inheritance tax for value in excess of £325,000.
At the start of the 2017/18 tax year, another allowance, the additional residential nil-rate band (RNRB) was also introduced.
This entitles us all to a further £100,000 of tax free allowance to offset against the value of the property you nominate as your main residence but only if it is left to children (including step-children) or grandchildren. The new exemption doesn’t apply if the family home is passed on to a brother, sister or other family member and relates only to the one property you nominate as your main residence – any other properties that form part of the estate such as second homes or buy to lets remain subject to Inheritance Tax.
Inheritance Tax threshold changes
This additional £100,000 RNRB allowance will increase over the next few years, rising to £125,000 in April 2018, then to £150,000 in 2019 and finally to £175,000 in April 2020.
What’s more, this allowance can be transferred to a surviving spouse if you are married, potentially doubling the tax-free assets that can be left to your loved ones. Single or divorced people will be able to pass on a maximum of £500,000 to their children without them being liable for inheritance tax, while couples can potentially pass on £1m. Any outstanding mortgage must be deducted from any property’s value before the impact of the allowance is calculated.
Couples who are neither married or in a civil partnership will not be able to pass on unused RNRB to their surviving partner. This means that there is an element of discrimination for those who cannot, or choose not,to get married.
The allowance is also tapered away for those with estates worth more than £2m: for every £2 in extra wealth over £2m, £1 of the allowance will be removed.
Why the change has been made
With house prices on the rise again following the recession and with the cost of living increasing, many more people are becoming liable for Inheritance Tax each year.
The Inheritance Tax threshold of £325,000 hasn’t changed since April 2009, and – according to the Nationwide house price calculator – if it had risen in line with inflation, it would now be £434,000. Thousands more people have now been caught by this tax.
The National Association of Estate Agents and the Association of Residential Letting Agents have forecasted an increase of 50% in house prices over the coming decade, with average prices reaching £419,000 by 2025. The changes to the Inheritance Tax rules mean that more people will be protected from being caught in the Inheritance Tax net,at least in the immediate future.
Example of the rule in action
Let’s assume Gloria died in July 2017 and leaves her children a home worth £300,000 plus £120,000 in cash and other assets. The new rule means that £100,000 can be subtracted from the property value which, when added to the £120,000 of other assets, gives a total of £320,000. There is no inheritance tax to pay as the total sum falls short of the £325,000 threshold. If she was married,the £5,000 left over couldbe transferred to her husband.
Reducing inheritance tax bills
Fortunately, there are a number of ways to reduce the amount of Inheritance Tax paid. Here are a few examples of what you can do to bring your assets below the £325,000 tax free threshold.
Gifting is one example and there are several options that can be used to reduce any IHT liability. Large sums can be given away but in order for these amounts gifted to be exempt from Inheritance Tax, you must live for a minimum of seven years after the gift is made.
Smaller gifts are less likely to ever be caught by Inheritance Tax.
An annual tax-free gift allowance of up to £3,000 exists, which you can make in cash or assets even if you are in poor health. This can be made to anyone you choose to give to. In addition to this, an unlimited number of gifts worth £250 can be made in any one tax year to individuals of your choice.
Gifts up to a value of £5,000 can also be made to a child(or £2,500 to a grandchild) when they get married or enter a Civil Partnership without ever being subject to any Inheritance Tax.
It’s worth being aware, however, that if transferred, certain assets are subject to Capital Gains Tax, so check with a professional before making decisions about gifts.
Charitable donations are exempt from inheritance tax. If you left 10% of your estate to a charity, the amount of inheritance tax owed on the rest is reduced, and although the saving may not be especially big, your beneficiaries will receive more than they otherwise might, and a good cause will benefit too.
While life insurance doesn’t directly impact the amount of inheritance tax owed, it can make paying the bill a little easier on your descendants. In order for this to happen, your life insurance must be written in trust during your lifetime – if it is not, it will be valued as part of the estate and be liable for inheritance tax as well.
Inheritance tax planning and advice
THP Chartered Accountants offers comprehensive Inheritance Tax planning and advice. Visit one of our offices in Wanstead, Cheam, Chelmsford, Saffron Walden or London City for assistance with your future plans, or call 0800 6520 025 to find out more.