Inheritance tax: Britons warned of ‘important caveat’ when legally reducing bill

Inheritance tax explained by Interactive Investor expert

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With inflation on the rise, house prices soaring, and the inheritance tax threshold frozen for five years, more and more families could get caught in the IHT trap, and left to pay out thousands to The Treasury. Darran Harrison, wealth planner at Kingswood spoke exclusively to about how families can reduce their inheritance tax (IHT) bill and pass assets to their loved ones.

Inheritance tax is charged at 40 percent of the value of an estate above a certain threshold, usually £325,000.

The Chancellor announced in the 2021 budget that there are no plans to increase the IHT thresholds until April 2026 at the earliest despite the backdrop of rising inflation and soaring house prices.

Passing assets to loved ones or down the family tree is one way to reduce the value of an estate and therefore reduce the potential tax bill.

Spouse and civil partner exemptions
Mr Harrison encouraged Britons to make use of their spouse and civil partner exemptions.

He said: “Married couples and civil partners can make use of each other’s tax-free allowance without special tax planning. Gifts and transfers between married couples and civil partners living in the UK are IHT-free, so if the first partner to die leaves their entire estate to the other, no tax will be payable.

“It’s also likely that none of their nil-rate band has been used, and the partner will be able to add the unused balance to their own, effectively doubling the threshold.

“If your partner is not UK-domiciled however, limits can apply, and you should seek advice.”

Annual gifts
Additionally, people should consider making annual gifts this new tax year, he said.

Single gifts of £3,000 per year can be made completely free of inheritance tax either to one person or split between several people. This allowance can be carried forward one year if people don’t use up all their allowance.

In addition, Britons are able to make small gifts of up to £250 per year. There is no limit to the number of recipients in one tax year, and these small gifts will also be IHT-free, provided they have made no other gifts to that person during the tax year.

He explained that gifts in consideration of marriage or civil ceremony are another potential option, subject to limits according to who is making them.

Regular gifts out of excess income can be made for IHT purposes, subject to specific affordability tests and qualifying criteria.

Lifetime gifts
As well as annual gifts, Britons can make Lifetime gifts

Mr Harrison said: “You can make larger gifts of money. These are called potentially exempt transfers (PETs) and can be made at least seven years prior to death, however, this comes with some conditions.

“One duly being that the assets must be an outright gift (rather than, say, loaned or a gift with reservation) and another is that, should the donor die within the seven-year period, IHT becomes payable on a sliding scale.

“There’s an important caveat however, determining whether such a gift is exempt only happens after your death, and is subjective.

“There’s a risk some gifts may be classed as being within your estate for IHT purposes if the taxman decides they did affect your lifestyle for example; therefore, if you are making habitual gifts it’s important to document your intentions and keep a record of this with your will.”


Life insurance
Mr Harrison suggests that Britons should consider taking out life insurance and look into it to reduce one’s bill.

He explained that life insurance can be a “simple but effective way to cover an IHT bill”.

He said: “You take out cover and place it under trust (so that the pay-out falls outside of your estate) and on your death it clears any IHT bill without exacerbating the tax situation.”

Other considerations
Mr Harrison continued: “Other considerations to help reduce your IHT bill are gifts to political parties, charities, trusts and amounts paid into private pensions are other avenues which the British public could potentially explore to dramatically reduce their inheritance tax bill.”

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