Tax trap! Is your estate worth between £2 and £3 million? If so you could lose valuable allowances

We deal with many affluent clients and it is interesting how attitudes to inheritance tax can vary significantly, even between people with similar levels of wealth.

Some say that they have paid taxes all their lives – on their income, asset sales, property purchases – and begrudge paying the treasury even one more pound in inheritance tax when they pass. Others feel that it will be someone else’s problem, so why should they worry.

Most people are somewhere in the middle. They don’t want to give so much away in their lifetime that their lifestyle is diminished, but equally they would like as much as possible of their estate to go to their family rather than the tax man.

The IHT Trap

I recently met a client who had never really worried much at the thought of paying inheritance tax. Both of his adult children are financially well off and will be able to provide amply for his grandchildren. He has enjoyed making generous lifetime gifts to the family and has always thought he’d be comfortable with the government taking their 40% after exemptions.

Then he discovered about the additional £140,000 in tax he would pay because his estate is worth £3 million rather then £2 million.

Why does this happen?

The reason for the additional £140,000 tax bill is because on top of the normal nil rate bands (£325,000 each) there are residence nil rate bands (£175,000 each). For a married couple of civil partnership that means £350,000 of nil rate band at 40%, so £140,000 in tax terms.

There are various conditions that need to be met in order to claim the £175,000 or £350,000 on the second death:

1. There must be a home in the estate worth at least the amount of the claim (or if the house was sold or downsized after 8 July 2015 you can use the value of the original property).
2. The home or cash equivalent must pass to direct descendants.
3. The estate must be worth £2 million or less to claim the full amount. There is a taper between £2 million and £2.7 million, after which the relief is lost altogether

Taking Action

This information was a game changer for my client. He realized that by making sufficient gifts between now and when himself and his wife have both passed away to reduce his overall estate to below £2 million he could save not just potentially 40% of tax on the amounts gifted but also the additional £140,000!

The flexible aspect of the residence nil rate band claim is that it only takes into account the value of the estate at death. Therefore even if a gift was made within the previous seven years, which will fall back into account when calculating the overall IHT due on the estate, it will not affect the ability to claim the additional nil rate band.

In theory assets can be gifted away just before death to secure the valuable relief.

What do I Need to be aware of?

One word of caution – be careful if the assets in question are liable to capital gains tax, so land and property, stocks and shares etc.. There may be capital gains tax to pay on such gifts.

In my client’s case he has significant cash savings so this is not a concern.

Even if there is CGT to pay it will undoubtedly still be worth making the gift but you should seek professional advice so that you are fully aware of all the tax consequences.

Inheritance Tax Planning

Don’t forget there are plenty of other ways to minimize your inheritance tax liability, such as making full use of annual allowances, using the regular gifts out of income relief, making charitable donations, investing in AIM listed shares.

Alternatively you can take out insurance to cover some or all of the tax liability, leaving more for your family to enjoy.

Or the best inheritance tax planning of all – spend your excess capital have a really good life!!

For more Information

If you’d like to discuss all things inheritance tax contact Jan Friend who will be happy to help you.

Here are some more of our estate planning blogs:

Top Ten Ways To save Inheritance Tax

How to avoid Inheritance Tax on a Property

Death bed Tax Planning – Is it worthwhile?

The content in this blog is correct as at 28 April 2022 See terms and conditions.