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This information is intended to give a broad overview of Inheritance Tax together with some ideas about how to write a Will that makes effective use of allowances and exemptions.
If you want more detailed or personalised information we recommend that you seek advice from a solicitor or financial adviser.
What is Inheritance Tax?
How is an estate transferred?
How is IHT calculated?
How can I avoid paying IHT?
Which transfers are exempt from IHT?
What are lifetime transfers?
What happens if I am married?
What is Inheritance Tax?
Inheritance tax (IHT) is tax paid on the transfer of an
estate. Your estate consists of any money and property that you own outright.
How is an estate transferred?
An estate is commonly transferred after death. This is
carried out by an executor, if a Will exists. If there is no Will, the estate
is transferred according to the rules of intestacy.
It is possible to transfer part of an estate during one's
lifetime. This is called making a 'lifetime transfer' and may reduce the IHT
payable on the estate.
How is IHT calculated?
IHT is payable in bands, similar to income tax. There
are two of these bands.
The first band is equivalent to your tax free allowance and is called the 'nil
rate' band, because IHT is paid at 0%. In the tax year 2007/2008 the nil rate
band covers the first £300,000 of an estate. The upper limit of the nil
rate band is reviewed each year.
The second band applies when the estate is valued at more than £300,000.
It is paid on the value of the estate that exceeds £300,000. The rate
is 40% for transfers made after death but may be less for lifetime transfers.
£300,000 may seem a large amount. However, you might be surprised at how
much your estate is worth, especially if you own your own home.
How can I avoid paying IHT?
Tax avoidance is illegal. You can however take steps legally to
minimise your liability to IHT. These include:
Which transfers are exempt from IHT?
You may make any number of individual gifts of up to £250.
You may also make gifts totalling £3000 each year to any number of individuals. If an individual gift is more than £250, it will be deducted from the £3000 allowance for that year.
What are lifetime transfers?
A lifetime transfer is a gift made during a person's lifetime
and, because it may become exempt from IHT, is known as a Potentially Exempt
Transfer (PET).
When the Inland Revenue are calculating how much IHT should be paid they will
only look at gifts made in the last seven years of someone's life. This means
that, if you make a gift and live for at least another seven years, no IHT will
be payable on that gift. If you do not survive for seven years, IHT will be
payable, but at a gradually reduced rate, known as 'tapering relief'.
If you die within three years, there is no relief and IHT will be paid at 40%.
If you die in the fourth year, the amount will be reduced by 20%.
Death within the fifth, sixth and seventh years attracts 40%, 60% and 80% relief
respectively.
What happens if I am married?
Transfers made to a husband or wife are exempt from IHT.
Therefore, if you leave your entire estate to your spouse, no IHT will be payable
on your death. However, the question remains as to how to limit the tax liability
of the estate of the second spouse when they finally die.
A solution is to make a mirror Will, with both Wills leaving an amount equal
to the 'nil rate' amount, to beneficiaries other than the surviving spouse.
The residue of the estate goes to the other spouse.
When the first spouse dies, the survivor should change their Will accordingly.
When they die, the 'nil rate' band will be applied for a second time.
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