Robert Webb, associate at Roythornes Solicitors, highlights steps that can be taken to reduce your IHT liability in a straight forward manner, without unnecessary complications in the future.
At this time of year we are bombarded with communications from banks and other financial institutions suggesting that we must make the most of our allowances for ISAs prior to the end of the tax year. These allowances are something that most of us are aware of and, wherever possible, do make use of, but that got me thinking about some of the lesser known tax benefits that are freely available, but not necessarily publicised in the same way, and certainly not by HM Revenue & Customs (HMRC).
Much of my time is spent advising on Inheritance Tax (IHT) and the ways in which people can reduce their liability. After all, IHT is very often viewed as a voluntary tax as there are legitimate ways in which the liability can be reduced and, in some cases, avoided altogether.
In simple terms, IHT is payable at a rate of 40% on assets that exceed £325,000 in value. Unfortunately, the IHT threshold hasn’t altered since April 2009, although we have seen a slight change following the introduction of the Residence Nil Rate Band (RNRB) in April 2017. However, the application of the rules in respect of the RNRB is unnecessarily complex and it is not an allowance that is available to everybody; there are very strict requirements as to who should benefit in order for the relief to apply.
As always, we hold out hope that there may be some sea change in the way in which IHT is applied to estates, but unfortunately what we hope for never quite materialises. Following Philip Hammond’s 2018 Spring Statement, there were certainly no ‘giveaways’ to speak of. With that in mind, making use of exemptions that are freely available becomes even more important, especially at this time of year, as some of these exemptions can be carried forward for a single tax year only.
So, what steps can be taken to reduce your IHT liability in a straight forward manner, without unnecessary complication in the future and value needed to be added back into your estate for IHT assessment? Here are my top tips:
- It is possible to give away up to £3,000 in each tax year, without any IHT consequence whatsoever. This is known as an annual exemption. It can also be carried forward for one tax year. Therefore, assuming you didn’t give anything away last year, you would have the annual exemption for 2017/18 and also the exemption for 2016/17.
- There is an individual gift allowance of £250 to any number of people. This is in addition to the £3,000 annual exemption, although beware because if you were to give an individual, say, £300 that figure would eat into your annual exemption. Those people that have benefitted from your annual exemption wouldn’t be able to benefit from this exemption as well though.
- One of the most overlooked exemptions in my experience is gifts out of surplus income. If you have a net income that exceeds what you need to maintain your standard of living then it is possible for you to give away the surplus. There should be a pattern to these gifts, and they should also be made on a regular basis. It is particularly important in this case that you keep very thorough records of the net income, what your general expenditure is and the “surplus” that you have available. I often see grandparents making use of this exemption for the payment of, for example, grandchildren’s school fees.
- If you have a relative that is going to get married any time soon, it is possible for you to make use of a wedding or civil partnership gift exemption. For your child, this exemption is worth £5,000, for grandchildren or great grandchildren it is £2,500 and for any other person it is £1,000.
A combination of the above can work very well indeed, as shown in the example below, which deals with transfers made over a very short period of time. Making use of these exemptions on a more regular basis, over the course of many years, can lead to significant tax savings in the long term.
Frank and Lynn are in their early 50s and their daughter Sarah is due to get married over the forthcoming Easter weekend. They want to know what they can do to immediately reduce their estate for IHT, but don’t necessarily want to give away a huge sum of money as they have plans for their retirement and exotic travel.
They have not made any lifetime gifts previously, so they could each give to Sarah their annual exemption of £3,000 for the tax year 2017/18 (total £6,000). In addition, as neither of them used anything last tax year, they can also give her their annual exemption of £3,000 for the tax year 2016/17 (total £6,000). On her wedding day they could also each give to Sarah £5,000 thus making use of the wedding gift exemption (total £10,000).
This means that they could give Sarah a total of £22,000, which would immediately improve their IHT position, without any continuing liability to IHT or negative consequence. Furthermore, on 6 April 2018, they could also give to Sarah a further £3,000 each (total £6,000) using their annual exemption for 2018/2019. This means that within the next four weeks, they could theoretically transfer to Sarah £28,000, none of which would be added back into their estate for IHT assessment. In real terms, this is a tax saving of £11,200 by making use of freely available exemptions rather than relying on surplus income or potentially exempt transfers.
However, it should not be forgotten that in addition to all of the exemptions above, it is possible for you to transfer much larger sums of money, and after a period of seven years (the often referred to ‘seven year rule’) the value of that transfer will be outside of your estate for IHT purposes. If you are in fine fettle, potentially exempt transfers such as this are well worth considering provided you can afford to do so. Transfers involving anything other than cash require further consideration in respect of Capital Gains Tax and should certainly not be completed without the benefit of appropriate advice.
Robert Webb is an associate at Roythornes Solicitors.