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Inheritance tax may be payable when you die. It is based upon the value of your estate (what you own less your debts at the date of death). Not everyone's estate will be subject to inheritance tax. But with the value of many properties rising you may find that your estate will be liable. This article considers some of your questions.
How much inheritance tax is payable when I die?
The rate of inheritance tax is 40%. However, the first £234,000 of your estate may be free of tax. For example, suppose you die with an estate worth £300,000. The first £234,000 suffers no inheritance tax so that your exposure to inheritance tax will be 40% times £66,000, which equals £26,400. This means that your heirs will inherit £274,600.
Who pays the inheritance tax?
When you die, your estate will be administered by your "personal representatives". If you have made a will (and you are generally advised to do so and check it every five years), your personal representatives will be the executors of your will.
They will pay any inheritance tax due to the Inland Revenue when they obtain grant of probate so that they can wind up your affairs.
Are certain bequests exempt from tax?
Yes. If your will leaves a gift to any charity (or mainstream political parties), that gift will be excluded from the calculation of the value of your estate.
Similarly, you do not need to pay inheritance tax in respect of any gifts to your spouse. But if your spouse is from overseas, there may be special rules applying and you should seek advice from an accountant or lawyer. Also exempt are certain "business assets". Basically, if you own a business you will usually be able to pass that on tax-free.
If I give away most of my assets, can I avoid the inheritance tax liability?
Yes and no. If you make any gifts within seven years of your death then they will be treated (for inheritance tax purposes) as if they were part of your estate. So they will not escape inheritance tax.
For example, suppose you die leaving an estate valued £200,000, but a year before your death you gave £100,000 to your children, your estate will still be liable to inheritance tax of £26,400 as calculated above. Gifts made more than seven years before your death will be fully exempt from inheritance tax. Also exempt will be gifts to charities and your spouse (as above).
Does this only apply to gifts of money?
No. A gift includes any asset in your estate.
What happens if the total value of my gifts exceeds the exempt amount (£234,000)? Does that mean that my total estate may be used to pay inheritance tax?
No. Your personal representatives must look in date order (earliest first) at the gifts you made in the last seven years of your life. The first £234,000 will be exempt from tax. The rest will be taxable, but at a special rate. This is shown in the table below. The tax is payable by the recipient of your gift.
The rest of your estate will be taxed at 40% in the usual way. The table shows that earlier gifts suffer tax (if any) at lower rates than later gifts. Yrs between gift and death | Max rate on gifts | 0 - 3 yrs | 40% | 3 - 4 yrs | 32% | 4 - 5 yrs | 24% | 5 - 6 yrs | 16% | 6 - 7 yrs | 8% | 7 or more yrs | 0% |
Because your gifts are looked at in order, it is important to make sure that avoid different people facing different liabilities from similar gifts. For example, suppose you give away £200,000 to your son on 25 December 2000 and a similar sum to your daughter on 26 December. Suppose also you die during 2001. If you have made no other gifts, the gift to your son will be fully exempt as it is for less than £234,000. However, when your daughter's gift is considered, the total will exceed this amount. Tax will be payable on the excess (£166,000). So your daughter will be liable to inheritance tax of £66,400. You can avoid this anomaly, if you make such gifts on the same day.
Do I have to keep a record of all gifts I make (eg birthday presents)?
No. Certain gifts may be ignored:
they include gifts of less than £250 per year,
wedding presents of up to £1,000 (or more for close relatives), and
other gifts totalling £3,000 in any year.
I have read that I can give my home to my children but carry on living there. Will that save some tax?
Unfortunately not. If you give an asset away, but continue to use it as if you still owned it, then you will not escape the inheritance tax liability. If you want to give away your home but you still want to live there, you will have to pay your children a reasonable rent. Then the value of your home will escape inheritance tax (subject to the seven year rule). But your children will have to pay income tax on the rental income.
What is Joint Tenancy?
Most couples own their home as "Joint Tenants", which means that each of them owns the whole of the property at the same time. When one of them dies, the house will AUTOMATICALLY become the sole property of the survivor, who can then do what they like with the house. This can cause problems.
If the survivor re-marries, it is possible for the property to pass to the new spouse on the death of the survivor, thus disinheriting the children of the original marriage. If the survivor has to go into a Nursing or Residential Home whilst the sole owner of a property, then a Local Authority has powers to charge the cost of care against the value of the whole house again disinheriting the children.
What is the answer to the problem of Joint Tenancy?
The answer to both these problems is to change the way in which you own your home from "Joint Tenants" to "Tenants in Common", a straightforward process that does not involve your Mortgage company, if your property is mortgaged.
As Tenants in Common each owner, in their Will, has the power to do what they like with their share of the property on their death. It will often be left in trust for the eventual benefit of the children. At the same time, the survivor has the full use of the property, and can sell it and purchase another one, and still keep one half of the value safeguarded for the children. Therefore, if the surviving spouse re-marries, they will own half of the value of the house, and could thus only pass on that amount to the new spouse. In addition, if the survivor is taken in to care, the Local Authority can only charge the cost of care against one half of the value of that property In either case, your children will inherit half of the value of the house. This facility can also be used as part of your planning to reduce a potential Inheritance Tax liability.
I have a home in Kenya. Is that subject to inheritance tax?
Provided you are British, then inheritance tax applies to all the assets in your estate, wherever in the world they may be. You may also be liable to inheritance tax in another country (depending on their rules). In this case, you might be able to reduce your UK liability by reference to the tax paid overseas. If you are not British (and have not lived here for many years) you will only be liable to inheritance tax in respect of your assets in Britain on your death. But the law is difficult here and you should seek professional advice .
Some people say that inheritance tax can still be reduced. How is this possible?
It can be possible to arrange your affairs in a very tax-efficient way. But this can be expensive. You should seek professional advice.
Finally, ensure that Life Assurance Policies and contribution refunds from Private Pension Plans and Death In Service benefits from Occupational Pension Schemes are, if applicable, assigned, nominated, or written in Trust for the benefit of your wife or children. This will enable such monies to be paid directly to the appointed beneficiary without forming part of your estate and therefore excluded from the Inheritance Tax valuation.
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