The UK is in the midst of a historic shift in wealth. If the current predictions come to pass, around £5.5 trillion will be passed down from one generation to the next by 2050. With this unprecedented transfer of wealth, the government will acquire record receipts of Inheritance Tax (IHT).
For those unfamiliar with IHT, this tax is effectively a death duty levied on the total value (less any liabilities, exemptions and reliefs) of an estate at the time of death. The Office for Budget Responsibility (OBR) has forecast that IHT will raise £7.5 billion in 2024-25, a considerable boon for the Treasury. IHT is usually paid at a rate of 40 per cent on the value of an estate above a threshold of £325,000. This threshold was set in 2009 and is frozen up to 2030.
Given that this threshold has not changed, tax efficiency becomes important and it is therefore no surprise that people are looking to explore ways of passing on their wealth in a tax efficient way. You would normally hope that the amount of an estate on which no tax is paid would increase regularly as inflation and house prices increase. The fact that it has been static for so long is equivalent to increasing the proportion of the estate that becomes taxable.
However, giving away your wealth is not always straightforward. Everyone’s situation is unique, so there is no one-size-fits-all plan for transferring wealth in the most tax efficient manner.
What are the usual exemptions and reliefs from IHT on wealth given away on death?
In most cases, assets left to the spouse or civil partner of the deceased will typically be exempt. So too will assets left to a charity. Any unused threshold can be transferred to a surviving spouse or civil partner, increasing their combined threshold to up to £650,000. There is an additional maximum transferrable main residence nil rate band of £175,000 each available when a home is left to the deceased’s children or other direct descendants. Where the conditions are satisfied, this increases an individuals’ estate threshold before inheritance tax becomes due to £500,000 and for couples (civil partners and spouses) to £1,000,000. This is also frozen until 2030.
With regard to charitable legacies, there is an additional benefit if 10 per cent or more of the net value of the estate is left to charity. In those circumstances the rate of IHT is reduced to 36 per cent for the whole estate. The impact of this is that one in four wills prepared by a lawyer now contains some form of charitable giving. Across the country, this is a trend which appears to be increasingly important to people planning the management of their estates. It cannot be understated how imperative it is to obtain legal advice to ensure that your charitable gift does not fail and that the legacy you intended can be achieved.
If you are intending to give a significant gift to charity, it is advisable to work closely with the charity or perhaps a philanthropic adviser, to make sure you support the charity in a manner which will ensure the greatest benefit.
What about giving assets and wealth away during your lifetime?
Gifts can include money but also ‘chattels’ (a Middle English term relating to tangible personal possessions), such as jewellery or antiques. Gifts can also encompass property and other investments including shares. There is no IHT payable on gifts between spouses or civil partners.
You can also give away up to £3,000 worth of gifts each tax year without them being added to the value of your estate. If your child, grandchild or any other person you know is getting married there are certain amounts that be given away free from tax. Regular gifts made for birthdays and Christmas, for example, will also be exempt. In addition, you can give as many gifts of up to £250 per person as you want each tax year, as long as you have not used another allowance on the same person.
You can also make regular payments to another person, from your own surplus income, for example to help a child with monthly rent or providing additional financial support to an elderly relative.
What is the seven-year rule?
On the surface, the rule is simple: if you make a gift and survive for another seven years there will be no tax to pay on that gift. If, however, you die within seven years of giving a gift, it will potentially become taxable because it is deemed to remain in your estate for inheritance tax purposes. The tax may be tapered in respect of the amount above £325,000 gifted and paid at less than 40% if it was given more than three years before your death.
We always advise clients to beware of retaining benefit. What this means is that if you give away an asset but reserve the benefit the seven-year period will not apply unless and until you give up the benefit and the full value at the date of your death will remain in your estate for tax purposes.
Commonly, for example, this might include living in a property you have given away or keeping an antique or work of art in your home having gifted the ownership of it. There are familiar ways around this. The most routinely practised method is that the donor of the property gift pays a market rent for the house they continue to live in to the recipient.
Not all gifts are equal
If you are making successive gifts to people with the intention of gifting equally, you should be aware that the gifts may not all be treated the same in terms of tax.
The first gifts in time within the seven-year period before death will benefit from the deceased’s Nil Rate Band currently £325,000. Subsequent gifts within the seven-year period will be subject to IHT and HMRC look to the recipient of the gift to pay the tax before they look to the estate to pay the tax.
Make sure your gift is valid
Tax efficiency is not the only consideration when giving during your lifetime or through a legacy in your will. You should also be mindful to ensure the gift is legally valid to ensure that disputes are unlikely to arise in relation to whether a gift has taken place or whether a donor had capacity to give the gift.
Taking professional advice from legal and financial professionals and ensuring your intentions are clear and well-documented is essential. Preparing to give away a lifetime’s assets to loved ones can carry significant emotions, so an objective analysis from an impartial expert is invaluable.
