Simply follow these four quick steps to work out your potential inheritance tax liability.
Gifts you give away during your life are known as ‘gifts inter vivos’. Most people, when they make a gift inter vivos, are looking to reduce the value of their estate, lessening or avoiding inheritance tax.
Inheritance tax is a tax due on most assets (possessions, property and cash etc.) you own at the date of your death.
If your total estate (which is made up of all of your assets considered relevant property subject to inheritance tax) is worth more than £325,000 as a single individual, your estate will have to pay tax at 40% on anything worth over this £325,000 threshold.
Large gifts you make to individuals while you’re still alive are not considered exempt from inheritance tax.
Such gifts are considered potentially exempt transfer or PETs and only become free of inheritance tax if you survive 7 years after making them. (Note that you may have to survive 14 years for the gift to be free of inheritance tax if you’ve given any gifts into trusts prior to making the PET.)
If you die within 7 years — and potentially up to 14 years — of making gift(s) in excess of your nil-rate band, the onus is on the recipient of the gift(s), not your estate, to pay the inheritance tax bill due on the gift. So if you don’t want to leave your loved ones with a nasty surprise after you’re gone, you’ll have to plan carefully.
If you die within 7 years of making the gift, inheritance is due on a sliding scale on that gift as follows:
Years Between Gift and Death
Less than 3
If you’re considering making a significant gift to a friend or loved one, especially one over your available inheritance tax threshold (£325,000 for a single individual), then you may want to consider a gift inter vivos insurance policy to cover the inheritance tax bill that may be due on the gift.
This is to protect the recipient of the gift from a potential inheritance tax bill that may be due if you fail to survive for 7 years after making it.
Without a gifts inter vivos policy, the recipient of the gift may have to pay inheritance tax even though the money could already be spent. Perhaps if the gift were for a house purchase, for example, and the sale goes through, then it’s unlikely the recipient of the gift will have the spare capital to pay the inheritance tax bill due some years after the gift was made.
A gifts inter vivos policy will pay out on a sliding scale to match the taper relief available on a large gift above your inheritance tax threshold, sparing the recipient of the gift from having to find the cash long after they received the gift.
Assume Marianne has a £1 million estate. She has a daughter. In January 2019, while she’s alive, she gifts her daughter £400,000 to fund a house purchase.
Marianne has not made any gifts to individuals or trusts prior to this and her other gift exemption had already been used up on a separate bout of gift giving. Unfortunately, Marianne dies in January 2020 after making the gift.
In cases where gifts have been made from an estate and the donor subsequently dies before the required number of years, the deceased’s nil-rate band allowance is applied to the gifts before it can be applied to an estate (as the gifts were made first).
Inheritance tax on Marianne’s £400,000 gift
Value of gift / PET:
Nil-rate band allowance:
Taxable value of gift:
IHT Liability on Gift
£75,000 x 40%
Remember: In the case of a ‘failed potentially exempt transfer’ above then nil-rate band it’s the recipient(s) of the gift(s) who are liable for the inheritance tax bill that’s been created. So, as Marianne died within the first 3 years of making the gift, her daughter will be required to pay a £30,000 inheritance tax bill.
Fortunately, Marianne has purchased a gift inter vivos policy to cover her daughter for this liability. The policy was written in trust with her daughter as a trustee.
A gifts inter vivos policy is a Life Insurance policy which is tied to the taper relief available to PETs, meaning it paid out the full £30,000 inheritance tax bill as Marianne died in the first 3 years after making the gift.
Had she lived longer, the policy would have paid out on a sliding scale to match the tapering down of the tax that would have been due on the gift until the prerequisite 7 years were survived and the policy could therefore end.
Marianne’s gift doesn’t erase all the inheritance tax liability on her estate. She still has an estate worth £600,000 to pay inheritance tax on and no nil-rate band as this has been exhausted on the failed PET. Plus the £400,000 failed PET becomes a ‘chargeable consideration’ and is re-added back on to her estate.
Marianne’s Inheritance Tax Calculation in 2019/20
New estate value
Less nil-rate band allowance:
-£0 (used up by the PET)
Less main residence allowance:
Taxable value of estate
Marianne’s IHT Liability
£850,000 x 40%
As you can see, as well as the inheritance tax due on the gift, because the nil-rate band has been used up by the PET, Marianne’s estate ends up having a larger inheritance tax bill as a result.
This means that Marianne may also want to consider taking out a Whole of Life Insurance policy to cover this liability, which is an insurance policy that lasts for your entire life, right up to death, and pays out a lump sum then.
When it comes to passing on your estate to your loved ones it can get complex quite quickly and often requires professional expertise to help you navigate the many pitfalls. If you need inheritance tax advice then please do not hesitate to pop us a call on 02084327334 or email firstname.lastname@example.org.
Calculating and then mitigating a potential Inheritance Tax Liability can end up being a bit of a headache without professional support.
If you need some help please do not hesitate to pop us a call on 02084327333 or email email@example.com.
Director at Drewberry