What is Inheritance Tax?
Inheritance Tax, or IHT, is a complex area. However, put simply, it is the tax levied on property, money and assets (collectively known as one’s estate) when they pass away.
Individuals who have an estate with total assets above the IHT nil-rate band (£325,000 in 2020/21) may be liable to a 40% tax charge on the value of the estate above the nil-rate band.
Inheritance Tax was first introduced in 1986 and the nil-rate band originally increased year on year, to reflect that the value of people’s estates would rise over time, for example, due to the rise in house prices over time. However, in 2009, the nil rate band was frozen at £325,000 and has not increased since. As the nil rate band remains frozen, this had led to a significant increase in the amount of Inheritance Tax collected over time. In the2010-11 tax year, HMRC collected £2.7 billion in Inheritance Tax. In the 2019-20 tax year, this had increased to a whopping £5.2 billion (HMRC, 2020). Although, 2019-20 did see a fall in Inheritance Tax collected after a peak in 2018-19 of £5.4 billion.
In the 2017/18 tax year, the residence nil rate band was introduced to reduce the number of families that were forced into the position where they had to sell the family home to pay the inheritance tax bill. For a large number of individuals, their home is the largest asset in their estate. The residence nil-rate band is currently £175,000 and will only apply if the family home is passed to your direct descendants, other than when the home is left to the surviving spouse or civil partner in the event of the first death. Whilst the Residence Nil-Rate Band will help reduce the amount of Inheritance Tax paid, the total amount of Inheritance Tax paid is still expected to rise over future years due to the rising value of people’s estates.
Inheritance Tax may not be at the forefront of our minds; however, planning for Inheritance Tax can reduce the amount of Inheritance Tax that your estate pays upon your death. In fact, a record amount of Inheritance Tax was collected in the 2018/19 tax year; a total of £5.4 billion was collected, according to HMRC data (HMRC, 2020).
So, how do we reduce the amount of Inheritance Tax that we pay?
There are many ways to reduce the amount of Inheritance Tax that would otherwise be payable, such as:
· Gifting assets away during your lifetime
· Setting up trusts
· Maximising the use of annual tax-exempt allowances
· Investing money into assets that qualify for reliefs from Inheritance Tax
· Gifting money to charity
Whilst it does not reduce the amount of Inheritance Tax payable, taking out a life insurance policy to pay the inheritance tax bill can reduce the impact that Inheritance Tax can have on an inheritance.
The Financial Conduct Authority does not regulate Trusts and Inheritance Tax Planning.