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Can you pass on a £1m home without inheritance tax?

Ed Monk, Fidelity Personal Investing, 15 December 2016

The amount handed over in inheritance tax is rising fast.

The latest figures published by the Government in July showed there was a 22% jump in the receipts from the tax (IHT) in 2015-16 compared to 2014-15, taking the total to £4.7bn.

IHT is still a minority concern, just 3.4% of estates paid it in 2013-14, the last available figures, but the proportion is growing.

Much of the rise has been driven by house prices that continue to rise, dragging more estates over the £325,000 threshold beyond which the tax is potentially due. That threshold has been kept stubbornly in place by successive governments despite inflation.

More and more families are planning finances across generations, with inheritance from parents and grandparents increasingly important to the financial security for younger generations, particularly to pay for house deposits.

It isn’t all bad news, though. Changes over the past ten years have given greater flexibility to reduce IHT liabilities - and another significant change is coming in April. Here’s what you need to know.

How IHT works

When a person dies, anything they own - their “estate” – up to the value of £325,000 can be passed on with no IHT due. This is known as the “nil-rate band”. Your estate can include any money held in cash or investments, property and other possessions. 

Anything over the nil-rate band can potentially face 40% tax, but there are significant exceptions that can reduce what has to be paid.

Crucially, anything that is passed to the husband, wife or civil partner of the deceased attracts no IHT at all. If other people benefit from the estate, including children, then the value of their inheritance is tested against the nil-rate band. If the value is below £325,000, there is nothing to pay.

Spouses can share unused nil-rate band

While the nil-rate band for IHT has not been raised in line with inflation, an important change was made in 2007 that increased the scope for avoiding IHT - allowing spouses and civil partners to pass unused nil-rate band to one another on death.

If a person dies and passes their entire estate to their spouse or civil partner and no-one else, there is no IHT to pay. The change meant that the deceased’s unused nil-rate band could also be shared, taking the surviving spouse’s nil-rate band to £650,000.

If something is passed to other beneficiaries apart from a spouse, such as children, the value of this is subtracted from the nil-rate band being shared. So a husband dying and passing £100,000 of inheritance to his children would leave £225,000 of his nil-rate band to his surviving wife, who could then add this to her nil-rate band, meaning she could pass on £550,000 without paying any tax.

More shelter from IHT is coming - £1m home tax-free?

In April, families will have more protection from IHT if an estate includes a main residence passed to direct descendants. The change is designed to help children avoid selling a family home to pay IHT.

To achieve this, an additional £100,000 of nil-rate band will be available to individuals in this situation in 2017/18, rising to an additional £175,000 in 2020/21. By that point, these people will have a total nil-rate band of £500,000 each.

When combined with spouses’ ability to share unused nil-rate band, it will eventually be possible for parents to pass a £1m property to their children without attracting IHT.

Pension protection from IHT

A pension that is not yet in payment is not usually included in your estate so can be passed on without IHT applying. There are some income tax implications, however, and what you pay depends on the type of payment, the age of the person passing it on and when the pension was established.

If an individual dies before age 75, most lump sums from defined contribution and defined benefit pensions can be passed on without any tax being due, but will count against the recipient’s Lifetime Allowance. If after age 75 the beneficiary will have to income tax on the money if withdrawn, subject to their own tax position at the time.

IHT can be a consideration when it comes to planning your retirement finances and may require specialist professional help.

For less complicated situations, the Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.pensionwise.gov.uk or over the telephone on 0800 138 3944.

Gifts and other IHT planning

Those with significant IHT liabilities, including land assets, could benefit from more complex tax exemptions, or legal structures called trusts. Such arrangements will require the help of a financial adviser or accountant.

Other than that, it is possible to give modest sums away before you die without the money being caught by IHT. You have an annual £3,000 allowance for 2016/17 and it is possible to carry over unused allowance from one year to the next, taking the maximum allowance in that year to £6,000. You can’t however accumulate several years of allowances to use on a larger gift.

Furthermore, you can give anyone £250 without attracting IHT, and you can make as many £250 gifts to different people as you like - although not to someone who has already benefitted from your £3,000 annual allowance.

Larger sums can be given with no IHT due if sufficient time passes before the giver dies. Such gifts - called “potentially exempt transfers” – become free of IHT once seven years has passed. If the giver dies before seven years, IHT is payable. How much depends on a taper, with the tax bill falling as time passes.

There are extra exemptions from IHT for wedding gifts, gifts to charity or political parties.

Another exemption exists for money given away from “surplus income”.  To qualify, gifts must be regular and maintained without diminishing the giver’s standard of living – it may be necessary to prove this in order to qualify for the exemption.

Important information

The value of investments and the income from them can go down as well as up, so you may not get back what you invest. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.

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