Categories
Couples Dads Mums Renters Self Employed

Inheritance Tax, the full guide

A heavy, sinking sigh often introduces the issue of taxation. Civilian commentators, and their press counterparts alike, seem to unify in their frustrations about, in particular, the sensitive matter of inheritance tax. We all want to leave behind a legacy. It’s a bit of a slippery term – its definition almost fluid to the whims of modern politics. What can we learn about inheritance gifts? And how can we actually leave behind something valuable without losing out?

What is Inheritance Tax?

The current measures on inheritance can be crushing to loved ones receiving a gift. Whether the gift is moneyed in value, a property, or possessions, your family could pay 40% tax against their inheritance within 7 years from a loved one passing.

Meanwhile the Office of Tax Simplification (OTS), after challenging the complexities of tax talk, are eager to create change. In their consultation with the UK government, the OTS aspire to drive coherency in the design of tax. A cleaner, softer language in our tax structures would mean that those, in their older age, who wish to leave behind gifts can more easily understand the benefits of inheritance. It’s important that financial planning be an accurate exercise.

Despite the immediate reality of those who will have to pay Inheritance Tax each year, which is only small in number, the worry about it is far greater in the public imagination. This is confirmed by a spokesperson for the OTS and represents a growing stress for taxpayers who struggle with mismanaged expectations that can frustrate their financial plans.

There is a human story here. The common motif, caught in a sort of repeat, is a feeling of frustration, if not something worse. The drive to protect yourself financially, in the sense of inheritance, has become something of an incurable itch.

How does Inheritance Tax work now?

Inheritance Tax will only affect your gift (property, money and possessions ) if the estate meets the value threshold of above £325,000. And the circumstance of the beneficiary, the recipient of the gift, can change the outcome of their inheritance, especially if they meet the criteria for tax relief.

According to a BBC report, the estimated estates to become liable for this tax each year is fewer than 25,000, otherwise about 5% of the population. There is an obvious communication error between the immediate, and actual, expectations for a taxpayer and what the perceptions of their annual taxes might be.

“Reform”, the modern cry for change, is close by when we talk about death tax in the UK. It’s outgrown its whisperings, with more experts wanting to see meaningful, if thoughtful, change.

Tax exemptions

It’s not that easy navigating the exemptions of inheritance tax.

If an inherited gift is “written in trust”, such as the funds held in a life policy, then the value is removed from the estate of the deceased. In short, it frees up your policy’s benefit to be pay-out as a tax-free lump sum. You won’t pay anything below this value of £325,000.

Yet, anything above this sum, the minimum threshold, and you add a 40% tax after the value (so your first £325,000 isn’t taxable). Let’s write that into an equation (assuming your property is over the threshold).

                (Property value £ – £325,000) x 40%

If your home is valued at £450,000, where the tax threshold is £325,000, then you would pay tax on the value carried over the limit. In this case, you’d pay a 40% tax on £125,000 (worked out as £425,000 – £325,000). Your tax bill will equal £50,000 (figured out as 40% against £125,00).

In other scenarios, you can extend your threshold and change the allowance. This is normally the case if you nominate your spouse (or civil partner) as the party to access your benefit. If you choose another exempt beneficiary, such as a charity, you could also clip the tax outright.

Putting life insurance in trust can also skip probate, which would equal to a faster release of your policy’s funds to your loved ones. It can also help to ensure that your funds go more directly to your beneficiaries, as per your instructions, to limit funds lost to tax.

There is, generally, a 7-year rule on qualifying tax-free gifts. Parts of an estate can be gifted within this time and will be viewed as a “gift”, meaning that it avoids inheritance tax. Yet, this is subject to evidence, which is tricky to surface for 7-year intervals of time (where, for example, the likes of bank statements will only travel back 6 years.)

How could things improve?

Though rumours initially, now the forums are charged with hard protest-like arguments to shake things up.

The OTS have suggested a reform against the current design that tapers relief over time and, instead, suggests we move toward a higher annual gift allowance. This comes as a timely response to the rising apprehension amongst the British public over inheritance gifts.

To further intrigue, YouGov polled a sampling of the British public on what they call ‘tax fairness’ – an otherwise clever metric to gauge national opinion on the matter of tax. The tax type that, according to this poll, is least fair is inheritance tax. Interestingly, this is a uniform opinion that travels across political boundaries amongst civilian voters, from labour to conservative advocates. There is little dispute, where public opinions matter, that inheritance tax attracts negative perception.

Reactions

There’s always a face behind the story.

When we trade stories about inheritance tax, either in scenarios that cause financial upset, or moments of relief, it would appear to be an anecdote, or someone’s real experience. These connect well with us; emotions become excited with the good and disenchanted, or boiled, with the bad. The Telegraph, for example, published a four-part series on “loop-holes” that all vie into the personal life of Britons tackling inheritance tax.

These human stories always find a way in – to our feeds, our opinions, our emotions. Central to them is a message for practical change, whether offering up alternatives, design fixes, or by asking for the simplification of inheritance tax.

Tax by numbers

Indeed, these human stories speak, voluminously, to the shared upset and grief of tax. But what are the numbers saying?

In the FT Advisor, there’s a nod to the total inheritance tax bill bringing home £5bn in the UK. The 2018/19 financial year hauled in record highs, too (with receipts tallying at $5.4bn). Yet, its’ worth contextualising that against a relatively low number of people who actually pay inheritance tax.

Top Takeaways

  1. Estates valued at less than £325,000 are exempt from inheritance tax.
  2. Alternatively, tax relief applies to a gift left behind to a husband or wife, partner, charity or community club.
  3. As a general rule, a gift is exempt from tax if it is primarily funded from income rather than savings.
  4. You can figure out the value of your estate by adding up the financial assets (insurance pay-outs, cash in the bank, property/ land and other valuables the likes of cars) and deduct any debts or loans at the time of death.

Glossary

  • IHT is shorthand for inheritance tax (you won’t read it here, because we’ve kept the language clean, but elsewhere you may come across this abbreviated form).
  • Nil rate band (NRB) is a handle for a gift on inheritance tax that falls below the minimum threshold for taxing. This has been frozen for over a decade (or since 2009).
  • The Residence Nil Rate Band (RNRB), or home allowance, is where you pass your home, or share of it, to your children.
  • Tax exemptions (or avoidance) is where your assets do not qualify for tax, meaning you won’t pay inheritance tax against your wealth.