Inheritance Tax Allowance

The inheritance tax allowance is important when planning to mitigate your inheritance tax liability. In simple terms, it’s what the government allows you to pass on tax free, with everything in your estate above this figure subject to inheritance tax when you die. But it’s a little more complicated than that . . .

What is inheritance tax?

Inheritance tax is a form of tax that you pay when a friend or loved one passes away and leaves you their estate. It is payable by the executor of such estate usually before your intended beneficiaries can receive their inheritance. It is only paid when the estate (combination of your property, money & possessions) is worth over a certain amount, which is commonly referred to as the inheritance tax allowance.

The Inheritance tax allowance is subject to government review, which makes preparing your finances to avoid this tax feel like you are the donkey with the carrot hanging on a string, all while your chances of avoiding the tax are repetitively pounded with a stick by changes to legislation, increasing financial prosperity and personal circumstances!

What is the current Inheritance Tax Allowance in the UK?

The current inheritance tax allowance for an individual in the UK (As of August 2016) is £325,00 and it is officially known as the nil rate band. It is called this because inheritance tax within this band is chargeable at a nil rate).

Put simply an estate that is above £325,000 will be liable to pay IHT on anything over £325,000.

Inheritance tax allowance

Currently there is an outrageous 40% tax rate for an estate that is above the inheritance tax allowance, so if you do not prepare your finances the costs can be significant.

Combining Inheritance Tax allowances

If you are married your spouse will not be subjected to inheritance tax when you pass away, however the liability remains for when they eventually pass away.

The inheritance tax allowance of £325,000 does however apply per individual and therefore a married couple can benefit from a combined IHT allowance of £650,000, before any potential tax liability will arise.

Gifts, Exemptions and Avoidance

Fortunately there are a number of gifts and exemptions available which can help to avoid this inheritance tax.

The simplest one being, gift your funds to your family and staying alive* for at least 7 years after making the gift.

*(I’m not entirely sure whether this is what the Bee Gees were singing about . . .)

Apart from this simple method, many of the options available to legitimately arrange your affairs to avoid Inheritance Tax are complex and go beyond the scope of this article.

It is therefore essential that you consider expert assistance from a qualified, expert and experienced financial adviser. Here’s a FREE guide to help you find the right one.

A highly skilled financial adviser will not only know all about the inheritance tax allowance, but they will also take time to properly consider how it would affect your overall financial affairs.

Furthermore, the right financial adviser will not allow the inheritance tax allowance liability to become the sole consideration, to the detriment of your wider financial objectives and position.

It is important to make the correct decisions in this regard and therefore expert advice is essential, it will take a rare individual to be capable of correctly arranging their inheritance tax affairs without professional assistance.

To highlight how the effects of inheritance tax and poor planning can be so detrimental to your finances and your family’s wealth, here are two examples of poor outcomes.

Example 1 – You ignore the problem and pass away with a sizeable estate.

Say for instance you were married with 3 children and you and your spouse die with a combined estate of £2,000,000. Your inheritance tax allowance would only be £650,000 and therefore your 3 children will have a problem.

As £1,350,000 of your estate is above the inheritance tax allowance, a tax rate of 40% would apply to this sum, creating an eye watering liability of £540,000.

As the majority of your estate’s value is made up of your main residential home, in order to pay this tax, your 3 children have to sell the property due to financial constraints, when it was always intended that your younger child, who looks like they will become financially successful in later years, would buy out the other siblings and maintain the family home.

Instead of your 3 children receiving £666,000 each, they will only receive £486,666; a considerable loss of wealth of £180,000 per child!

*The government has announced some changes to the inheritance tax allowance if you own your home.

Example 2 – You do not take high quality financial advice before choosing your inheritance tax allowance solution

You have the foresight to recognize the problem and come up with a simple solution to the issue of inheritance tax; you simply gift the majority of your assets to your son.

However, you haven’t properly considered your family’s financial affairs and your future financial position and therefore this gift has a detrimental impact on your finances in later years.

 As you expect to live at least 7 years your gift to your son will become exempt from inheritance tax.

However just a few years later your son experiences a messy and stressful divorce at the same time as his own company suffers from a downturn in business.

Your son therefore becomes significantly poorer and his ex wife now has a large amount of your intended inheritance!

Worse still, in later years the lenses of hindsight make you realise that you gifted away too much of your estate!

You miscalculated how much money you will need in the future and always expected your son would be able to assist you financially if the need arose.

However there is now nothing that can be done and you spend your remaining years living frugally, with your remaining finances hit by the combined detrimental forces of inflation, medical and long term care costs.

What can you do?

Unfortunately these types of scenarios happen all too frequently.

The government received £3.4Billion in revenue during the tax year 2013/2014 alone from estates that were above the inheritance tax allowance.

To ensure you do not add to this figure and your family’s wealth does not suffer, it is imperative that you seek advice from the right financial adviser who can not only look at your inheritance tax problems, but will also ensure that you fully consider and arrange you entire financial position in an effective manner.

Many solutions available to reduce a potential inheritance tax liability take time to become effective; therefore it is essential that you do not leave it until it’s too late and speak with the right professional today.

I can personally put you in touch with the right financial adviser who can help you improve your finances.

You can contact me here and I firstly recommend you read my FREE guide to financial advice.

Get in touch today for a personal, independent, and comprehensive financial plan.

Mark Underdown | DipPFS IMC CeMap

Financial Planning Consultant


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