Inheritance Tax (IHT) remains a largely voluntary tax because there are a myriad of ways to legitimately avoid paying it.  Solutions may be simple or complex, expensive or low cost.  In my experience, most people prefer simple and low cost solutions.

 

Gifts between spouses and Civil Partners are exempt from Inheritance Tax.  However, gifts to other family members, unless using one or more of the available gifting exemptions, are only exempt from Inheritance Tax if you survive for seven years after making them. Lifetime gifts into most types of trust are potentially subject to a lifetime Inheritance Tax charge of 20% on the excess of the gift above your Nil Rate Band of £325,000 with further Inheritance Tax potentially payable if you do not survive seven years after making the gift.  Of course, married couples/civil partners are entitled to two Nil Rate Bands meaning a combined total of £650,000.

 

So as long as your cumulative non-exempt gifts over a seven-year period do not exceed £325,000 each, assets can be gifted by you to, say, your family without attracting an Inheritance Tax charge on the gifts themselves (although they will use up your Nil Rate Band for seven years).  Gifts made directly to other individuals are known as PETs (potentially exempt transfers).  A PET escapes IHT altogether if you survive more than seven years after the date of the gift.  Otherwise, it becomes chargeable. PETs are not liable to the lifetime rate of Inheritance Tax of 20% which is half of the death rate of 40% as they only become chargeable on death within seven years.  

 

 

 

 

So if you gift up to £325,000 (your Nil Rate Band as it is known) every seven years and survive for seven years each time you save £130,000 Inheritance Tax (40% x £325,000) that you would have paid had you kept that amount of money in your estate on death.  Your spouse or Civil Partner also has a Nil Rate Band (an Inheritance Tax-free allowance) which he or she could use to gift up to £325,000 every seven years too.  So combined you could save up to £260,000 IHT every seven years!

 

Repeat the process every seven years so that you save £520,000 after 14 years, £780,000 after 21 years and £1,040,000 after 28 years.  Start the process in your mid-fifties and you will have not only gifted £2.6 million (£325,000 x 2 x 4) by your early eighties, you will have saved more than £1 million in Inheritance Tax too!

 

 

 

 

 

Sounds too good to be true?  Not really.  This is perfectly acceptable and legitimate estate planning.  It’s also very simple as long as you avoid the pitfalls along the way.

 

So what are the potential pitfalls?

 

  • Falling foul of the 14-year rule for Inheritance Tax (read explanation below)
  • Gifting  wealth to family members  and subsequently regretting your decision
  • Gifting so much wealth that you impoverish yourself e.g. underfunding care fees

 

The 14-year rule is where it becomes more complicated.  The Inheritance Tax computations will include any chargeable gifts that were made in the seven years before a chargeable gift was made (a chargeable gift means either a chargeable lifetime transfer – CLT – into trust or a failed PET that has become chargeable). This basically means that any chargeable gifts made up to 14 years before the donor’s death could affect the overall Inheritance Tax payable. This rule is there to ensure that gifts which become chargeable are taxed appropriately.

 

A failed PET arises where the donor gifts an asset which is at the time of the gift a potentially exempt transfer, but the donor then dies within seven years of making the gift so that the PET becomes chargeable to IHT. The PET will then use up some or all of the donor’s Nil Rate Band, resulting in more IHT on the estate, and any PET above the Nil Rate Band (when added to CLTs or failed PETs within the seven years before it) is subject to IHT on the recipient of the gift.

 

Gifts which are made into discretionary trusts are CLTs but as long as they are no more than £325,000 per person every seven years then no lifetime IHT is payable, but on death, within seven years they are included for IHT purposes.

 

 

 

 

 

 

So it is essential to get tax advice from an estate planning tax specialist.

 

Although each individual is only entitled to one £325,000 Nil Rate Band on death, each person can in fact utilise one NRB every seven years so multiple IHT free allowances of £325,000 can be claimed throughout the donor’s lifetime.

 

There are of course a myriad of ways to save Inheritance Tax but this is one of the simplest ways to do it and it avoids the complexity of many alternative IHT mitigation strategies.  Simple and low cost.  You know it makes sense.*

 

*The value of your investment can fall as well as rise and is not guaranteed. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist.  All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.