According to David Cameron, the UK’s previous Prime Minister, “only the rich should pay inheritance tax, not the hard-working people” … but this does not seem to be the case as asset values increase.
The current inheritance tax (IHT) threshold is £325,000 per person. It doubles to £650,000 for a UK married couple - as long as the first person to die leaves their entire estate to their partner. There is also a further £100,000 each if you leave your home to your children.
Anything over this limit is subject to a 40% tax bill.
So what sort of people are now having to pay IHT, and if that is likely to include you, how can you legitimately reduce your bill?
Property price increases are dragging many middle class working families into the tax bracket.
When do you pay IHT?
- First £325,000 is tax free
- First £650,000 for married couples is tax free
- A further £100,000 each is given if you leave your home to your children
- Thereafter assets taxed at 40%
The average price of property in London is now £514,000, while it has reached £338,000 in the South East. That means many single or divorced people who own their house, will owe tax on their estate when they die.
The Office for Budget Responsibility (OBR) calculates that 4.8% of the population currently pays IHT. By 2018-19, it estimates that figure will have more than doubled, to 10%.
In 1987 a house in north London was worth £115,000. It would now be valued at £800,000.
Many people would be upset to know that they have been paying income tax for years and now pay tax again should they pass away, owning over a certain amount of assets.
If you plan ahead, you can totally reduce or mitigate your IHT bill.
How to reduce your IHT bill
- Gifts of up to £3000 a year are tax free
- Gifts out of income are tax free
- Get married - your allowance doubles
- Put your assets in a pension. Usually inheritors pay less tax
- Give to charity. Your tax bill will be reduced
- Hand over your house - but you will need to live for seven years, and pay rent
- Family Trusts – certain Trusts allow your estate to reduce or mitigate IHT
Another option is to insure the bill. This does not remove the bill but will prevent your family from having to pay out of inherited assets. The sum assured is for the amount of the likely bill and put in Trust for the beneficiaries. When they receive the bill, they pay it from the proceeds of the life insurance.
If you are two UK Domicile people living together then it makes tax sense for you to marry. As a single person, your estate has an allowance of £325,000 then everything over this amount is taxed at 40% BUT if you are married to a UK Domicile, everything can pass tax free then the next heir, after your spouse goes, gets taxed 40% on GBP650,000 or over.
Changes to pension legislation could also offer a way around IHT.
You can transfer non-pension assets to fund a pension, and pensions do not get taxed for Inheritance. By shifting your savings into a draw-down scheme they will no longer be included in your final estate valuation, and therefore will avoid inheritance tax.
You can give up to £3,000 a year in gifts tax-free
Giving gifts is another way to reduce your final estate value. Each year you can give away £3,000 with these gifts falling outside your estate immediately.
You can also gift larger sums of money but these will stay within your estate valuation for seven years, another reason why it is good to plan ahead. Assuming you live for seven years, then these gifts fall outside your estate and avoid IHT.
A way to safeguard these gifts before the seven year deadline is for the beneficiaries to take out life insurance against an inheritance tax bill. This is especially popular for single parents who do not want children to have to sell the family home to pay a tax bill.
In addition, if you have an income - a pension, earnings, or dividend payouts - and you give money regularly, then it is also exempt.
And remember gifts to political parties and charities are also free of IHT.
Despite all the options available, unless you give your house away, it is hard to avoid inheritance tax on what is probably your most valuable asset.
Many argue that the threshold should at least rise each year in line with inflation, but now the rate has been fixed since 2009.
The key people who are caught up in inheritance tax are the squeezed middle. These are the people with the bulk of their wealth tied up in the family home...
Please feel free to contact me with regards to your own situation. There are ways to remove or reduce taxes with good planning in place.
+852 2542 2285