Inheritance Tax

What is Inheritance Tax?

Inheritance Tax (also known as IHT) is essentially a tax on death. It is often described as being "a voluntary tax", meaning that it is avoidable with the right assistance and planning. It is certainly true that many people are frequently astonished at the amount of Inheritance Tax that is payable upon the death of a relative or friend. With a rate of 40% payable on all assets over £325,000 (from April 2009) it is easy to see how the tax can mount up if care is not taken during your lifetime to minimise your potential liability. Take note that it is now possible for spouses and civil partners to transfer their unused inheritance tax nil rate band allowances.

So what can you do? While the simple answer is to give all your assets away before you die, this may not always be the most prudent and tax efficient way. Here are a few tips for you to consider, but it’s advisable to seek out professional guidance before taking any action.

Inheritance Tax exemptions

There are several exemptions to IHT, these are:

The nil rate band (Inheritance Tax threshold)

You only pay Inheritance Tax on cumulative transfers of assets over £325,000 (in 2010-2011). Below this figure it is a "Nil Rate Band”. £325,000 may sound like a lot, but remember it is absolutely everything that you own - including your house.

Transfers between spouses

No Inheritance Tax is paid on any transfer of assets on death from husband to wife (if both have the same domicile), or vice versa. Whilst this appears very generous it often merely delays the IHT liability until the other spouse dies. Since October 2007 it is possible for spouses and civil partners to transfer their unused inheritance tax nil rate band allowances.

Annual gift of £3,000

You can give away up to £3,000 worth of gifts every year to whoever you like, and if you can afford to do so, you should try and use this exemption every year.

Gifts out of income

Regular gifts out of surplus income, as opposed to capital, are exempt from Inheritance Tax. This is a little used, but quite useful exemption, but gifts do need to be regular.

Small gifts of up to £250

This is £250 per person, but it cannot be the same person you gave the £3,000 annual gift to. Useful if you have plenty of cash and several grandchildren.

Gifts on marriage

You can give £5,000 to your own child on their getting married, £2,500 to your grandchild and £1,000 to anyone else. Only applies to one marriage per person unfortunately.

Gifts to charities

Any gifts to charities are exempt from IHT .

Potentially Exempt Transfers

There are also what are called Potentially Exempt Transfers (PETs). Most gifts in excess of the exemptions given above made during your lifetime are exempt at the time that they are made, but are subject to your surviving for seven years after the gift was made. If you survive the full seven years then there is no liability to Inheritance Tax. If you die within this period of time then IHT will become payable. It may be at a reduced rate, but this only takes effect if you have given away more than £300,000 within three to seven years of your death. Here is a table which details the reduction in IHT on gifts made within seven years of death.

Finally, you should consider using trusts to avoid paying IHT. Check our Trusts page for more information.

Click here for advice on Inheritance Tax from an independent financial advisor

Share your experiences

Please note: The views expressed in community areas of this site do not necessarily reflect or represent the views of Law on the Web, its owners, its staff or contributors.