Inheritance tax: Parents will be hit by IHT as families donate early – how to lower your bill | Personal finance | Finance
Inheritance Tax (IHT) is usually paid by a deceased person’s estate and passes on their assets, as long as the total estate is valued at over £325,000. To try to reduce the costs involved, many may turn to freebies, but changing their habits about it can lead to more people facing costly bills.
Giving practices are changing
The government will allow people to gift assets tax-free up to certain limits, and many people will gift money to reduce the value of their estate and (hopefully) avoid the IHT. However, while many people typically pass on their assets when they die, often through a will, more and more families are choosing to do so while they are alive, increasing the risk of being affected by the IHT.
Recent research from Canada Life has shown that more than a third of parents (38%) have already passed on significant financial gifts to the next generation. Among those who had donated, the main reason for doing so was to support their children or grandchildren with general living expenses (21%).
Almost two-fifths (18%) said it was not for a specific purpose and that they simply wanted to reduce the value of their estate. While 17% did so to finance the purchase of a car and 15% to finance other major purchases.
Speaking to those who had donated to their children, 37% said they could afford to save money so it had little or no impact on them. However, 17% said that since giving the money they have run out of funds for emergencies and 15% have had to cut back on spending since giving the money.
Andrew Tully, technical director at Canada Life, commented on the research.
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He said: “The desire to pass on wealth to the next generation is not new, but traditionally it is done after death. Increasingly, many parents or grandparents wish to see their children benefit from the money at a younger age rather than waiting However, it is of concern for the financial future of the next generation that the most common use of these gifts is to provide for the costs of daily living rather than fund large one-time purchases.
“It is important that anyone wishing to make a financial gift to the next generation first seek financial advice. An advisor will help you determine how much you can safely donate without compromising the health or enjoyment of your own retirement, and ensure that this is done in a tax-efficient and efficient way.
“Research shows that more than 1 in 10 parents who donate believe it can have a negative impact on their own retirement planning. The right advice will help ensure people are fully aware of the consequences before making a donation. ‘to act.”
While pensions and retirement planning can be impacted by early giving, many may not be aware that it also has implications for estate planning.
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IHT rules on gifts
Currently, IHT may have to be paid on gifts given while a person is alive. The IHT may be levied if a gift, which includes money and personal property, is given less than seven years before the donor’s death.
No tax will be due on gifts if the person lives seven years after giving them, unless the gift is part of a trust. This is called the “seven-year rule”.
If a person dies within seven years of giving a gift and there is an IHT to pay, the amount of tax due depends on when the person made it. The IHT will be taken on a sliding scale known as the “conical relief”.
The taper relief rates are as follows:
- Years between donation and death – three to four years, IHT rate on donation – 32%
- Four to five years – 24%
- Five to six years – 16%
- Six to seven years – eight percent
- Seven or more – zero percent
These deadlines are important to note because while the IHT due on gifts is usually paid by the estate, once a person has given more than £325,000, recipients who receive a gift from them during these seven years will have to pay the IHT.
While many families may assume they won’t have to worry about IHT at all, the latest data from HMRC shows the government is collecting record amounts of the tax.
In mid-November, tax statistics released by HMRC showed Britons paid £392billion in tax between April and October this year, up £99.8billion from the same period a year earlier.
Of this amount, IHT accounted for £3.6 billion, which is £600 million more than the same period in 2020 and an increase of 20%.
Shaun Moore, tax and financial planning expert at Quilter, responded to these statistics. While he noted that donations can indeed help with IHT planning, caution should be exercised.
He said: “One of the factors likely contributing to the increase in IHT revenue is the surge in the housing market. Despite the end of the stamp duty holiday at the end of September, the race to space continues and this week’s ONS data showed a record average UK house prices of £270,000 With inheritance tax thresholds frozen, which is seen as a stealth increase in taxes, more people will face IHT bills as a result of selling their homes.
“This tax year you can pass on £175,000 of your property tax free, which is effectively doubled to £350,000 when combined with your spouse or civil partner’s allowance. This is on top of your Inheritance Tax Allowance – or zero rate band – of £325,000, meaning it’s possible to pass on a £1million inheritance for free as a couple.
“However, the RNRB only works for those whose direct descendants inherit the family home, while the UK’s six million co-residents are less fortunate and ineligible for combined benefits.
“There are other ways to reduce your inheritance tax exposure, such as gifts to family members. Each tax year you can give up to £3,000 in gifts with your annual exemption, so ‘as a couple, you can gift £6,000 a year, and there’s no limit on excess income – above expenses – that can be gifted.
“Unfortunately, donation allowances have not kept up with inflation, and the currently rising inflation rates will do little to help matters in terms of IHT bills. If necessary, you can also consider gifts larger ones that would be Potentially Exempt Transfers (PET) or Billable Lifetime Transfers (CLT), but these will take seven years to see the benefit of the IHT. In addition to reducing the taxable value of the estate, gifts are especially useful for estates impacted by the RNRB shrinkage, as donations can immediately recoup the extra band.”