inheritance tax

As we approach the end of the tax year, it is time to review whether there are any unused Inheritance Tax (IHT) annual allowances that could be utilised before 5 April which might otherwise be lost.

The rate of IHT is high at 40% and has effectively increased over time because:

  • The annual allowances have been unchanged for over 30 years; and
  • The nil rate band has not been increased for well over 10 years.

Therefore, if your estate exceeds the nil rate band of £325,000 for individuals (£650,000 for a married couple or those in a civil partnership) it is important to make full use of the annual allowances that are available to help minimise IHT liabilities on death later.

How can you manage your Inheritance Tax?

There are various annual allowances for Inheritance Tax purposes. These are amounts that can be given away each and every year in respect of which there is no immediate IHT liability nor is there a requirement that the donor survives for 7 years. These include:

The annual allowance of £3,000

This amount can be given to anyone. The allowance can be carried forward for one year if it is not fully used but the allowance for the current year must be used first. Therefore, as of today, if the allowance for the current tax year (2020/21) has not been used, it would be possible to use that and also any unused allowance for the previous year (2019/20) a total of £6,000 per donor straight away.

On 6 April, it would be possible to make a further tax-free gift of £3,000. Therefore, individuals who have yet to make use of the allowances for the 2020/21 tax year or the 2019/20 tax year, could potentially give away up to £9,000 over the course of the next month or so without any IHT liability and without having to worry about the seven-year rule!

The small gift allowance of £250

It is possible to give away any number of gifts of £250 to different individuals during the course of the year and again these are exempt from Inheritance Tax and are not affected by the seven-year rule. For example, a gift of £250 to each grandchild.

The normal expenditure out of income (“surplus income”) allowance

This is perhaps the most complicated of the annual allowances but also potentially the most generous.

In effect it allows an individual to give away their “surplus” income on an annual basis free of any IHT liability and again free from the seven-year rule. There are some conditions attaching to this relief but there is no upper limit on the amount that can be given.

Therefore, for an individual that has a relatively high income and low outgoings it is possible for them to give away the difference year in year out without any IHT liability. For example, if your income were £55,000 per annum and your outgoings (income tax, council tax, gas, water, electricity, food etc) were say £30,000, the difference of £25,000 could be given away free of Inheritance Tax in addition to the other annual allowances. That would create an IHT saving of £10,000 on the later death of the donor and this could be repeated year after year.

This allowance cannot be carried forward so it is a question of “use it or lose it”.

How to use surplus income to manage Inheritance Tax

The surplus income allowance is often used by grandparents or potential grandparents wishing to provide for grandchildren. However, the grandchildren may be too young to receive the funds directly or might not have been born yet!

One approach, so that the grandparents can plan ahead and retain control until the grandchildren are old enough to properly look after or manage the funds involved, would be for the grandparent to make an annual gift of all or some of their “surplus” income into a form of discretionary trust of which the grandchildren were the beneficiaries. The grandparents could be the trustees and therefore manage how and when they wanted the assets of the trust to be distributed to the grandchildren or used for their benefit. In the meantime, the grandparents would have made use of their annual allowance. The trust needs to be properly structured and must for example exclude the grandparents from benefitting.

The use of such trusts should be done as part of an overall IHT planning strategy and in connection with the updating and review of Wills.

If you’d like to discuss these or any other ways to save or reduce Inheritance Tax, please contact our private client team who can assist you.