The UK’s tax system is one of the most complicated in the world.
Inheritance Tax (‘inheritance tax’) is currently at a rate of 40% and applies when an estate is worth more than £325,000.
Inheritance tax is only paid on the amount that exceeds the limit and is paid out of the estate rather than by the inheritors as the default.
There are many ways inheritance tax can be reduced; we’ve set out some of the most relevant below.
The family home
The most commonly relevant exemption is the ‘residential nil-rate band’.
Where the family home (meaning a property the deceased has lived in at some point since owning it) is being transferred to a direct descendent, £175,000 more is allowed to be transferred tax-free.
So, where the family home is being passed on to a direct descendant, the threshold becomes £500,000 (the standard £325,000 + £175,000).
This applies when the total estate is worth less than £2 million.
There is generally no inheritance tax due on inheritance left to a spouse.
However, when the spouse is not based in the UK, there is a limit of £650,000 on transfers (nil-rate band of £325,000 + £325,000 spousal exemption).
A non-domiciled spouse can elect to change their domicile to the UK (as a ‘lifetime election’ or, if on the death of the UK-based spouse, ‘death election’) so that they can enjoy transfers free from inheritance tax from the domiciled spouse. In doing so, the surviving spouse will have elected to have their entire estate, including any overseas assets, subject to the UK inheritance tax.
The election ceases to have effect on non-UK assets once the individual has resided outside of the UK for more than three consecutive tax years following the date of the death. Where the surviving spouse leaves the UK for at least four tax years then they will be considered based abroad again and non-UK assets will cease to be liable to UK inheritance tax.
Where someone does not use their whole £325,000 nil-rate allowance, their spouse can claim it to increase their own nil-rate allowance by the percentage of that was left unused. As such, Wills should request that executors report how much of the nil-rate band has been used to the surviving spouse once everything is settled.
Gifts to charities and national institutions are exempt for inheritance tax.
If 10% of an estate is given to charity then the inheritance tax rate becomes 36% rather than 40%. This does not ultimately save money but it can inform your decision of how much to give to charity.
Not only can giving gifts in your lifetime minimise your inheritance tax liability, you can also give as you please as the sharia inheritance allocations do not kick in until your death.
There are many inheritance tax rules that can apply to lifetime gifts, here are the ones you most need to be aware of.
If you have a complicated assets or an estate above £2million, it is best to go to a tax specialist for a bespoke Will- we are happy to make introductions to a professional we can recommend. Contact us here.
£250 can be given to any person tax-free – with a limit of £3,000 in total for the year (so that’s 12 £250 gifts). If this £3,000 limit is not fully used one year, it can be carried over (but only to the next year).
Gifts can also be made tax-free if ‘in consideration of marriage’. There are a few rules for this:
- The gift must be made on or soon before the official wedding date.
- The wedding has to be completed.
- £5,000 max can be given tax-free if you are a parent.
- £2,500 max can be given tax-free if you are a grandparent.
- £1,000 max can be given tax-free from anyone else.
Notwithstanding the above, gifts made within seven years of the date of death are generally subject to inheritance tax (though after 3 years the inheritance tax rate reduces with every additional year that passes). Such gifts are known as ‘Potentially Exempt Transfers’.
There is a huge exception you should be aware of – the exception for ‘normal expenditure out of income’.
Income (wage, pension etc.) can be given away as a gift with no limit. This is so long as the gift is made on a ‘regular’ basis (e.g. Eid, birthdays) and does not affect the giver’s standard of living.
The Office of Tax Simplification stated that there are cases where over £1million is given away tax-free within a year using this exception.
If you’re considering gifting your residential home to your children, there will be no inheritance tax to pay after 7 years but you will need have lived there for at least 7 years, need to pay your share of the bills, and pay rent to the new owner at the market rate. You do not have to pay rent to the new owners if both you only give away part of your property and the new owners also live at the property
For those who want to their businesses to be passed down their family, the ‘business property relief’ allows for passing it on tax-free if the business property has been held for two years or more. This can also apply to some investments in AIM-listed companies.
This is why the trust-based will can provide tax advantages- the flexibility allows trustees to take professional advice so that they can make the most of the many exceptions available in the future.
Trust-based Islamic Will
For those who are liable to pay inheritance tax, we offer a trust-based will that provides added control and flexibility to navigate the tax system effectively and capitalise on tax exceptions. This enables trustees to handle the estate based on the specifics of the inheritance tax regime at the time of death as well as the individual circumstances.
This flexibility also proves beneficial in instances such as: when it isn’t clear how the assets will be split, when an inheritor is in receipt of means-tested benefits or when one wishes to leave the decision of who to distribute a gift or charity to up to the trustees.
A handy perk is that any distributions made by the trustees in the first two years of the trust being created will be read into the Will (and so treated as if written in at the time so that the trust can, if all distributions are made in that time-frame, be dismantled without additional cost). This is particularly handy given Islamic inheritors may change and you may not have had it updated to reflect that.
A discretionary trust does, however, get taxed on every 10-year anniversary of its creation at a maximum of 6% (any assets covered by the nil-rate band are excused from this). This sounds worse than it actually is – within the first 10 years any property transferred out of the trust will be treated as if it is still valued at the date of death whilst still using the most up-to-date nil-rate band threshold (and these tend to go up over time). This is called the Capital Gains Tax uplift on death.
Finally, if any inheritors are bereaved minors or disabled people, so long as their share can be distinguished within the trust, it can be ring-fenced for special tax treatment as a ‘trust for vulnerable people’. This can be claimed by submitting a ‘Vulnerable Person Election’ form. This will have inheritance, income, and capital gains tax benefits that are further explored here- https://www.gov.uk/trusts-taxes/trusts-for-vulnerable-people).
To find out more about our trust-based will see here.
This article is part of our Islamic Wills FAQ series.