Inheritance Tax (IHT) is a subject that many people prefer not to dwell on, but understanding its implications is crucial for effective estate planning. This tax is levied on the estate of a deceased person and can significantly affect the assets passed on to beneficiaries. Although IHT is often in the news it is estimated that less than 4% of estates in the UK are large enough to suffer the tax, but if you are exposed to IHT, careful planning can reduce your exposure.
Thresholds and Rates
The standard rate of inheritance tax is 40% on amounts over and above the nil-rate band. The nil-rate band is the amount up to which an estate will have no inheritance tax liability. For the tax year 2024/2025, this threshold stands at £325,000 per individual.
Additionally, there is a residence nil-rate band (RNRB) which applies to individuals leaving their main residence to direct descendants, such as children or grandchildren. The RNRB is currently £175,000 per individual meaning that each person can have £500,000 in their estate without suffering any tax if their main residence is included. This band is subject to various conditions and may be reduced for estates valued over a £2 million.
There is a way whereby an individual can reduce their estate’s tax rate and that is by leaving at least 10% of their estates net value (being assets less any debts) to charity. Giving away 10% will reduce the IHT rate to 36%, and there are scenarios where giving away 10% can leave the beneficiaries with more in their hand after the tax is deducted.
If an individual leaves their whole estate to their surviving spouse this will be exempt from IHT. Furthermore, the surviving spouse would also inherit their nil-rate-band and RNRB which could leave £1,000,000 available for the surviving spouse to leave to their beneficiaries without a charge to IHT.
Exemptions and Reliefs
There are various ways in which an individual can reduce the size of their estate without having to undertake a significant planning exercise.
Gifts to charity: Any assets gifted to qualifying charities during a person’s lifetime or in their will are exempt from inheritance tax.
Annual gift exemption: Individuals can gift up to £3,000 per tax year without incurring inheritance tax. The £3,000 can be given to one individual or be split between several recipients. This exemption can be carried forward for one tax year if unused but will be lost if not used by the end of the following tax year.
Small gifts allowance: Gifts of up to £250 per recipient per tax year are exempt from inheritance tax. There is no limit to the number of gifts that can be made to different people, as long as no one person receives more than £250.
Gifts out of income: Gifts made out of income can be exempt from IHT if they meet certain conditions. Broadly, the conditions are that the gift must be made as part of normal expenditure i.e. follows a pattern; The donor retains sufficient income to maintain their standard of living; and gifts are made out of income (for example pensions, rental income, dividends or bank interest).
Wedding gift allowance: Each year you can give a tax free gift to anyone getting married or entering into a civil partnership. The allowance depends on your relation to the persons involved, with a £5,000 exemption available for your child, £2,500 available for a grandchild (or great grandchild) and £1,000 available to anybody else.
Potentially exempt transfers (PETs): The above allowances and exemptions allow assets to fall out of the estate at the date of the gift, but this is often not the case. Gifts made within 7 years of death that do not attract any reliefs will still fall into a deceased’s estate. However, there is a taper relief so that gifts made 3-7 years prior to death have a reduced tax rate.
| Years between gift and death | IHT rate |
| < 3 years | 40% |
| 3 – 4 years | 32% |
| 4 – 5 years | 24% |
| 5 – 6 years | 16% |
| 6 – 7 years | 8% |
Qualifying AIM investments: Shares held in qualifying companies within the Alternative Investment Market (AIM) will become eligible for Business Relief once they have been held for 2 years. This allows the value of the investment to fall outside of the estate much quicker than the PETs mentioned above. Companies listed on the AIM are typically start-up businesses looking for quick growth so could be viewed as a riskier investment; however, it is worth noting that a 25% drop in value is more favourable than leaving the full amount exposed at 40%.
Further points For those with more complex or higher value estates there are other reliefs available, such as Business Relief and Agricultural Relief. Another popular method of reducing the value of an estate is by putting assets into a trust. Record keeping is essential when it comes to gifts. It will help the executors of the estate correctly identify which exemptions and allowances have been used and ensure that the correct amount of tax is paid.
If you have any questions about gifting or inheritance tax in general, please contact our tax team at tax@thomsoncooper.com.
The information in this article should not be regarded as financial advice. Information is based on our understanding of the legislation. Tax rules can always change in the future. Your own circumstances could have an impact on tax treatment.