30 Jan 2024

What you probably weren’t told about
Inheritance Tax

Most people won’t pay inheritance tax, but the number of people who will is rising.

In 2009/10 just 2.6% of deaths gave rise to IHT. Yet according to the Institute for Fiscal Studies this figure is set to rise to more than 7% over the next decade.

You might gift excess income to:

Basic allowances

For those who do expect to pay IHT there are certain allowances that are available.
The IHT threshold for 2023/24 is £325,000 per individual and it is called your Nil Rate Band. This is your basic allowance and the rate is typically 40% above this amount. If married, each of your allowances can be shared on first death meaning a possible £650,000 may be available on the second death of a couple. There is another allowance called the Residential Nil Rate Band of £175,000 per person, in respect of the family home, if left to the “bloodline” and your home is worth enough at death.

Lifetime gifts

One acceptable form of IHT planning is to make lifetime gifts. You can gift up to £3,000 a year while you are alive and it will not be added to the value of your estate for IHT purposes. Any of this amount that is unused can also be carried forward to the following tax year, though it cannot be carried forward beyond that.

You can also give smaller gifts that are worth less than £250. You can make as many of these smaller contributions as you want. However what you can’t do is combine the £3,000 and the £250 to the same person. Nor can you give multiple gifts of £250 to the same person. Gifts can also be made to children/grandchildren in celebration of marriage.

Gifts of more than the above are deducted from your Nil Rate Band, and then fall away if you survive for 7 years after the gift, at which point your full Nil Rate Band is restored.

IHT allowances for married couples

There is no IHT to pay on gifts between spouses or civil partners. You can give as many of these as you want during your lifetime provided your spouse lives in the UK permanently and is in a legal marriage or civil partnership with you.

An allowance that you may be less familiar with

Gifting from excess income

If you can demonstrate excess income, you are able to gift it outside of normal allowances each year, and you won’t be taxed on it. As long as you have enough income to maintain your standard of living, and as long as these gifts are regular and you keep good records of your incomings and outgoings, you can make gifts from the surplus income. 

You might gift this excess income to:

  • Pay off a child/grandchild’s student debt.
    By paying off student debt you can reduce the interest that would otherwise accumulate, removing an extra tax burden for a loved one.
  • Contribute to a child/grandchild’s pension.
    Anyone can pay into anybody else’s pension. The individual that has the pension gets the tax relief, but the parent or grandparent gets inheritance tax relief.
  • Gift the excess income into a whole of life plan.
    A whole of life plan is an insurance policy that is guaranteed to pay out for the insured’s entire lifetime as long as the required premiums are paid on time. If you’ve got excess income you can write it into trust so that it’s outside of your estate. You can then use that either to gift to children or grandchildren or you can use it for them to pay the IHT.

To do all this you just need to be able to prove to HMRC, after you’re gone, that this was genuinely excess income, and that’s why you gave it away each year. This is why it’s important to keep a record of your expenditure to show that the gifts didn’t affect your standard of living.

This type of record keeping may sound ominous but it isn’t as complex as it sounds. Regular gifts should be recorded on an IHT403 form, which can be downloaded here.

Beyond that it is a good idea to calculate income coming in and then deduct expenditure in the following categories: mortgages, insurance costs, household bills, council tax, traveling costs, entertainment, holidays, and nursing home fees. The excess of income over expenditure can then be gifted.

The rules around the excess income allowance can be complex so it’s a good idea to speak to your tax adviser first if you want to use this exemption.

Feel free to speak to one of our specialist advisors here at FiveWays and we can guide you through the process and make sure you’re planning for inheritance tax as effectively as possible.

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