Understanding Inheritance Tax in the UK
Inheritance tax (IHT) can be a significant burden on families when a loved one passes away. However, there are ways to save money on this tax, particularly by using some lesser-known exemption rules. In this guide, we will break down what inheritance tax is, how it works, and the three exemptions that can help UK households save up to £18,800.
What is Inheritance Tax?
Inheritance tax is a tax applied to the estate of a person who has died. An estate includes everything owned by the individual at the time of their death, such as:
- Property
- Money
- Personal belongings
Understanding the Allowances
Generally, you do not have to pay inheritance tax if:
- The total value of your estate is below £325,000, or
- You leave everything above the £325,000 threshold to your spouse or civil partner.
Additionally, if you pass on your home to children or grandchildren, the threshold can increase to £500,000. This rule gives you an extra £175,000 allowance.
If you are married or in a civil partnership and your estate is less than your threshold, any unused portion of that threshold can be passed on to your partner upon your death. This means that married couples can potentially leave up to £1 million without paying inheritance tax.
However, if your estate exceeds these allowances, a 40% tax could be applied to the portion above the threshold. To minimize this tax, you can use annual exemptions to make gifts while you are still alive.
Three Exemption Rules to Save on Inheritance Tax
According to Fidelity International, there are three lesser-known exemption rules that can significantly reduce your inheritance tax liability when it comes to gifting money.
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Annual Exemption
Each tax year, you can give away up to £3,000 in total. This means you can gift money to friends or family without worrying about inheritance tax on that amount. -
Wedding and Civil Partnership Gifts
You can give additional gifts to loved ones when they marry. The amounts are as follows:- £5,000 to a child
- £2,500 to a grandchild or great-grandchild
- £1,000 to anyone else
- Small Gifts Exemption
You can give £250 each year to as many people as you want, as long as you haven’t used any other exemption on the same person. This allows for multiple small gifts that won’t be taxed.
Maximizing Your Exemptions
By fully utilizing these exemptions, it’s possible to save a substantial amount on inheritance tax. If you maximize these exemptions, you could potentially save up to £18,800 in inheritance tax over time, especially as your gifts accumulate.
How to Approach Gifting
One effective way to manage your inheritance tax is to make regular small gifts using the annual exemptions. It’s important to recognize the following:
- If you give gifts but die within seven years of making them, those gifts could still be counted in your estate and taxed.
- However, gifts made while using the annual exemptions won’t be counted against your estate, even if you pass away soon after.
For couples, this means that you could potentially gift £42,000 every seven years, plus an additional £5,000 if a child gets married. This could lead to significant savings in inheritance tax.
A Couple’s Strategy to Save
Here’s a simplified way to think about it:
- By taking advantage of the annual exemption, a couple could give £3,000 every year per person, totaling £6,000.
- If they have a child who gets married, they can add another £5,000 to their gifts.
- Over seven years, this gifting strategy could allow them to give away a substantial £42,000 + £5,000 without incurring tax.
Conclusion
Though inheritance tax can be a complex matter, understanding how to leverage exemptions can provide enormous benefits for UK households. With careful planning and regular gifting, families can save up to £18,800 on inheritance tax, ensuring that more of their wealth is passed on to their loved ones. Taking the time to learn these rules and apply them can make a big difference in your financial planning.