Inheritance Tax warning: Three ‘crucial things Britons need to know’

Inheritance tax explained by Interactive Investor expert

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Many Britons fear falling victim to what is frequently noted as the death tax accidentally leaving their family with a bill larger than they can afford. However, nil rate bands, residence rates and gift exemptions are vital to avoid an unnecessarily large inheritance tax bill but many are unsure of where they stand.

The current IHT rate is set at 40 percent of the value of assets in an estate above the threshold. 

This is seen as a voluntary tax with a usual threshold of £325,000, however, because of this Britons cannot hope to save on their bill without deliberately working to do so.

There are multiple ways Britons can go about reducing their tax liabilities but using these methods without understanding what is being done can result in a far worse situation than just a tax bill. 

Christine Ross, Head of Private Office at Handelsbanken, shared what she noted as “Crucial things Britons need to know about inheritance tax”.

Nil rate bands

A nil rate band is also known as the threshold of value for which IHT does not have to be paid on an estate. 

Currently, the first £325,000 of an estate is non-taxable as it falls into the nil rate band but there are other non-taxable options too. 

If all assets in an estate is given to a spouse or civil partner then no IHT is payable. 

However, Ms Ross added: “If the nil rate band is not used for the first death of a couple in a marriage/civil partnership (because all assets are left to the surviving partner), then on the death of the second partner, both nil rate bands can be used by those inheriting, making a total of £625,000.”

Residence nil rate bands

This band is slightly different to normal nil rate bands as it refers specifically to provide exemption from IHT for a family home. 

Ms Ross explained: “This amounts to another £175,000 per person. As above, the RNRB is transferable between spouses/civil partners upon death. The total of the two nil rate bands plus the two RNRBs comes to £1million.”

However, Ms Ross noted there are a number of restrictions on residence nil rate bands:

  • The family home must be inherited by children or grandchildren
  • It cannot be used against lifetime transfers made within seven years of death
  • Net estate values over £2million will have their residence nil rate band reduced by £1 for every £2 that goes over this threshold. 

Lifetime giving

A highly underestimate aspect of IHT is the fact that it can be due for gifts one made during their life, not just after death. 

Currently, gifts made within seven years of death could likely incur IHT. In fact, gifts made within three years of the death will be taken into account when calculating the estate value. 

However, this is not bad news for households as Ms Ross explained: “There are a number of exemptions that allow lifetime gifts to fall immediately out of the estate, and not be subject to the seven year rule on IHT.”

This includes annual gift exemption which makes gifts of up to £3,000 every tax year fall outside of the estate. 

Small gifts exemption provides for £250 to be gifted to an unlimited number of people in the same tax year and normal expenditure out of income. 

The latter provides that gifts given out of income and form part of normal expenditure will not be taxable. 

Lastly, marriage or civil partnership gifts have a threshold as well, where each parent can gift £5,000, each grandparent can provide £2,500 and any other relative or friend can gift £1,000. 

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