What is inheritance tax?
Inheritance tax (IHT) is a specific tax imposed on the estate of someone who has passed away. It applies to the value of their property, money, and possessions above a certain threshold.
In the UK, the standard tax-free allowance (nil-rate band) is £325,000 per individual. Married couples and civil partners can combine their allowances, providing a joint threshold of £650,000.
Estates exceeding this limit are taxed at 40%. However, there are exemptions, such as the residence nil-rate band (an additional £175,000 if you leave your home to direct descendants) and reliefs for business or agricultural assets. Gifts to spouses, charities, and certain lifetime gifts are also exempt.
Gifts to spouses, charities, and certain lifetime gifts are also exempt.
Can I Gift My House to My Children?
Yes, gifting your house to your children can be an effective way to reduce inheritance tax, but it’s also essential to understand the rules and potential consequences connected to this.
Gifting Property Rules
When you gift your home to your children, it is considered a Potentially Exempt Transfer (PET). This means the gift will only become fully exempt from inheritance tax if you survive for seven years after making the transfer.
If you pass away within this period of 7 years, the gift may still be subject to inheritance tax, depending on its value and the taper relief rules.
What is the 7-Year Rule ?
The 7-year rule is a key aspect of inheritance tax planning. If you survive for seven years after gifting your home, the property is no longer part of your estate and is exempt from inheritance tax. If you die within seven years, the tax liability reduces gradually over time through taper relief.
Taper Relief is a tax reduction applied to inheritance tax (IHT) on gifts made before death, if the donor survives for at least three years after making the gift. It reduces the IHT rate on a Potentially Exempt Transfer (PET) based on how many years have passed since the gift was given.
How Taper Relief Works
If you gift assets to someone and pass away within seven years, inheritance tax applies, but at a reduced rate based on the following scale:
| Years Since Gift | IHT Rate Applied |
|---|---|
| 0 – 3 years | 40% (Full Tax) |
| 3 – 4 years | 32% |
| 4 – 5 years | 24% |
| 5 – 6 years | 16% |
| 6 – 7 years | 8% |
| 7+ years | 0% (No Tax) |
Potential Tax Consequences and Exceptions
- Gift with Reservation of Benefit: If you continue to live in the property after gifting it, it may still be considered part of your estate for inheritance tax purposes unless you pay market rent to your children.
- Capital Gains Tax (CGT): Your children may face CGT if they sell the property, as the gift is treated as a disposal at market value.
- Stamp Duty Land Tax (SDLT): If the property has a mortgage, your children may need to pay SDLT.
Gifting your home can be a valuable strategy, but it’s crucial to seek professional advice to navigate the complexities and avoid unintended tax consequences.
Transfer Property to My Spouse — Is It Tax-Free?
Spouse and Civil Partner Exemptions
If you are planning to transfer any of your property to your spouse or civil partner, it is important to know that this is completely exempt from inheritance tax. This means you can leave your entire estate to your spouse without incurring any tax liability. This exemption applies regardless of the value of the estate, making it a straightforward way to protect your wealth.
How It Affects the Inheritance Tax Threshold
If the first spouse to pass away does not use their full inheritance tax threshold (which is currently £325,000), the unused portion can be transferred to the surviving spouse. This effectively doubles their tax-free allowance to £650,000.
Example A
For example, if the first spouse leaves everything to the surviving spouse, no inheritance tax is due at that time. When the surviving spouse passes away, their estate can benefit from both their own and their late partner’s allowances, significantly reducing the overall tax burden.
This strategy ensures that more of your wealth is passed on to your loved ones, making it a key component of effective inheritance tax planning.
Using Trusts to Protect Your Wealth
Trusts are a powerful tool for managing and safeguarding your assets while reducing inheritance tax liability. Common types of trusts include:
- Discretionary Trusts: This is when trustees decide how and when their beneficiaries receive assets, offering flexibility and control.
- Life Interest Trusts: A beneficiary (e.g., a spouse) can use the asset during their lifetime, with the remainder passing to others afterward.
If you are placing your assets in a trust, they are no longer considered part of your estate, which helps to potentially reduce the inheritance tax burden. Trusts also allow you to set specific terms for all your asset distribution, ensuring that your wealth is protected and passed-on according to your wishes.
Annual Gift Allowances and Small Gifts
There is also another way you can reduce your inheritance tax liability. This can be done by making use of annual gift allowances. There are 3 most common kinds of annual gift allowances:
- Annual Gift Allowance: You can give away gift allowance up to £3,000 per year tax-free, and any unused allowance can be carried forward for one year.
- Small Gifts: You can give up to £250 per person per year without incurring tax, as long as they haven’t received part of your £3,000 annual allowance.
- Wedding Gifts: Parents can gift up to £5,000, grandparents up to £2,500, and others up to £1,000 tax-free as a wedding gift.
These allowances allow you to pass on wealth gradually while minimizing tax implications.
Example of Annual Gift Allowances and Small Gifts
Let’s say Sarah wants to reduce her inheritance tax liability by making use of her annual gift allowances:
-
Annual Gift Allowance:
- Sarah gifts £3,000 to her daughter this year. This is completely tax-free.
- She didn’t use last year’s allowance, so she can also carry forward £3,000, gifting a total of £6,000 tax-free this year.
-
Small Gifts:
- Sarah gives £250 to each of her three grandchildren (£750 total). These small gifts are also tax-free.
-
Wedding Gifts:
- Her son is getting married, so Sarah gifts him £5,000 as a wedding gift, which is tax-free.
In total, Sarah has given away £11,750 this year without incurring any inheritance tax liability, effectively reducing the value of her estate.
Leaving Money to Charity
Donating to charity in your will is a meaningful way to support causes you care about while also reducing your inheritance tax liability. Here’s how it works:
Charity Exemptions
Gifts left to registered charities in your will are 100% exempt from inheritance tax. This means the donated amount is deducted from the value of your estate before any tax is calculated.
For example, if your estate is worth £500,000 and you leave £50,000 to charity, only £450,000 is considered for inheritance tax purposes.
How Charitable Donations Lower the Overall Tax Rate
If you leave at least 10% of your estate to charity, the inheritance tax rate on the remaining estate drops from 40% to 36%.
For instance, if your estate is worth £500,000 and you donate £50,000 (10%) to charity, the taxable amount reduces to £450,000, and the tax rate on this portion lowers to 36%. This not only supports a good cause but also reduces the tax burden on your heirs.
Final Thoughts & How We Can Help You
The Importance of Early Estate Planning
Planning ahead ensures that your assets are distributed according to your wishes while minimising inheritance tax. By taking proactive steps, you can protect your family’s financial future and avoid unnecessary tax burdens.
Why Professional Guidance Matters
Inheritance tax laws can be complex, with various exemptions, reliefs, and planning strategies available. Professional advice can help you navigate these rules, ensuring your estate is structured efficiently to maximise tax savings.
Book a Health Check Review
Book a consultation with Heighten Wealth to develop a personalised inheritance tax strategy that safeguards your assets and secures your family’s financial future.
📅 Schedule a consultation today and take control of your estate planning.
FAQs: Your Inheritance Tax Questions Answered
Can I give my savings to my children?
Yes, you can gift your savings to your children. However, if you pass away within seven years of making the gift, it may be subject to inheritance tax under the 7-year rule. If you continue to benefit from the savings (e.g., by earning interest), it may still be considered part of your estate under the gift with reservation of benefit rule..
What happens if I move abroad?
If you move abroad and are no longer domiciled in the UK, your overseas assets may not be subject to UK inheritance tax. However, UK assets (e.g., property or bank accounts) will still be taxed. It’s important to seek professional advice to understand your tax obligations.
Are pensions subject to inheritance tax?
Most pensions are not subject to inheritance tax. However, they may be subject to income tax for the beneficiary, depending on the type of pension and the age of the deceased at the time of death.
Can I give away my home to avoid inheritance tax?
Yes, you can gift your home to your children or others, but if you continue to live in it without paying market rent, it may still be considered part of your estate under the gift with reservation of benefit rule. Additionally, the 7-year rule applies, meaning the gift will only be tax-free if you survive for seven years after making the transfer.
What is the nil-rate band, and can it be transferred?
The nil-rate band is the tax-free threshold for inheritance tax, currently £325,000 per person. If you’re married or in a civil partnership, any unused portion of this threshold can be transferred to your surviving spouse, effectively doubling their allowance to £650,000.
Are gifts to grandchildren tax-free?
Gifts to grandchildren are treated the same as gifts to children. You can use your annual gift allowance (£3,000), small gift allowance (£250 per person), or wedding gift allowance (£2,500 for grandchildren) to make tax-free gifts. Larger gifts may be subject to the 7-year rule.
How does leaving money to charity affect inheritance tax?
Gifts to registered charities are 100% exempt from inheritance tax. Additionally, if you leave at least 10% of your estate to charity, the inheritance tax rate on the remaining estate drops from 40% to 36%, reducing the overall tax burden.
Can I set up a trust to reduce inheritance tax?
Yes, setting up a trust can help reduce inheritance tax by removing assets from your estate. Trusts like discretionary trusts or life interest trusts allow you to control how and when beneficiaries receive assets while potentially lowering your tax liability.
What is taper relief, and how does it work?
Taper relief reduces the inheritance tax on gifts if you pass away within seven years of making them. The tax liability decreases gradually:
- 0-3 years: 40% tax
- 3-4 years: 32% tax
- 4-5 years: 24% tax
- 5-6 years: 16% tax
- 6-7 years: 8% tax
- After 7 years: 0% tax
Are business assets exempt from inheritance tax?
Certain business assets may qualify for Business Relief, which can reduce their value by 50% or 100% for inheritance tax purposes. This applies to assets like shares in unlisted companies or business property used in a trading business.
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