& Inheritance Tax Matthew was devastated when Alina died “ We knew it was going to happen, she had been diagnosed with cancer the year before. She was a very practical woman and she made sure her will was up-to-date, and re-filed all her papers so that I would be able to find everything. We tried to prepare ourselves for what would happen. She told me what she wanted me to do after she had died. She even wrote out what songs she wanted at her funeral. It may sound a bit cold but it wasn’t, it was just her way of Contents coping and of trying to help me cope. Is it something I need to worry about? _ 2 When I started trying to sort out her affairs, How does Inheritance Tax work? _____ 2 I was shocked. Before I can even start, I have Basic planning ______________________ 5 to pay a huge Inheritance Tax bill. I don’t know how I can find the money. I don’t want to The problem of the family home ______ 7 have to sell our home. We’ve been here for Are trusts the answer? _______________ 9 16 years and we spent so long decorating How to find an adviser ______________ 10 ” and making it ours. It’s where all my best Further information _________________ 10 memories are, and it’s our children’s home. Jargon buster ______________________ 11 Introduction Inheritance tax is no longer just a problem for from each other and cannot use each the filthy-rich: after years of rising house other’s inheritance tax allowance. prices (even with the recent declines) and This means they are also more likely to now a five-year freeze in the tax-free pay tax on anything they leave to other allowance, more and more ordinary people people, such as their children or family are finding themselves landed with a bill. members. It is particularly a problem for cohabiting In this guide, we’ll show you how couples, especially if they own their own Inheritance Tax works, how it is charged, home. Unlike married couples or civil and what action you can take to avoid partners, couples that live together potentially leaving your partner with a whacking great have to pay tax on anything that they inherit Inheritance Tax bill to remember you by. Is it something How does Inheritance Tax work? I need to worry Inheritance Tax taxes the The nil-rate band is set about? things of value you leave behind when you die. People against this total and used up against the earlier gifts It may be. Inheritance Tax is you have given things to can before the later. Your estate charged on any estate worth also be charged Inheritance is treated as the last gift you over £325,000 (for 2010–11 Tax on gifts you made make. Inheritance tax then and frozen at this level until during the last seven years has to be paid on any part 5 April 2015). This is the of your life. of the estate that is not ‘nil rate band’. Add up covered by the nil rate band everything you own, When you die the value of (£325,000 for 20010–11). including your share of the the things you own are things you own jointly with added up and any debts are Inheritance Tax has to be your partner, and subtract deducted. Any gifts you paid before your money everything that you owe, have made in the last seven and belongings can be including your mortgage and years that are not tax-free distributed to the people in things like loans, credit card are added to the sum. your will. bills, etc. If what’s left comes to over £325,000 you do need to be thinking about it. Remember, you really need to make a will. How bad is it? Without one, your partner will not It’s fair to say it can be a automatically inherit pretty painful bill to land on anything from you. your doormat. When you die, See our Wills leaflet anything over the nil rate for more details. band gets taxed at a rate of 40%. This can take a significant bite out of the amount you leave, which is not so bad if you’re leaving your money to a grown-up child or friend; but if it’s your partner, it can have drastic effects. It can sometimes mean they have to sell the home you’ve made together. The good news is that, with a little tax planning, you can reduce the amount or even avoid a bill altogether. 2 Living Together & Inheritance Tax • www.advicenow.org.uk/livingtogether Other exemptions Bill and Sarah There are also ways you can Bill and Sarah lived together for 14 years. The house give money and property was in Bill’s name but he’d left it to Sarah in his will. away without being subject When he died in November 2007, the house was to Inheritance Tax, even if valued at £320,000. you die tomorrow. The main ones are: Two years before he died his sister had run into money problems and he’d given her a lump sum to ● Anything you give to sort out all her debts. This had to be taken into your husband, wife, or account in Bill’s estate and, along with a bit of civil partner. This is savings and his car, brought the total up to £343,000. where unmarried couples really lose out and why The first £300,000 (the nil-rate band for 2007–8) was Inheritance Tax planning is not taxed. But the remaining £43,000 was taxed at the particularly important. rate of 40%. Sarah was left with an Inheritance Tax Some couples even bill of £17,200. At 2010–11 rates, the amount of tax consider getting married payable would still be substantial: the first £325,000 for this reason. (the nil-rate band now) is not taxed, but the remaining ● The first £3,000 of gifts £18,000 is taxed at 40%, which means tax of £7,200. you make in each tax year. If you didn’t use all of this allowance last year, Exemptions If you do die within seven you can use it this year too. years, the people you gave It can’t be carried over for There are, however, a those gifts to might also have more than one year. number of ways that you to pay Inheritance Tax on can give money to friends or them. But they will have less ● Small gifts of £250 or less. family members, either in tax to pay if you died between These are always exempt your lifetime or when you three and seven years after as long as the total you’ve die, without having to pay giving the gift than if you died given to any one person in Inheritance Tax on it. sooner after giving the gift. If any year is £250 or less (this they cannot or will not pay, the cannot be combined with Things you give away estate will have to pay instead. any gifts you made under more than seven years the exemption above). before you die ● Gifts to family and Most gifts to people you friends when they get make while you are alive are married or enter a civil treated as being exempt partnership – £5,000 is from Inheritance Tax (what exempt if it is your child tax advisers call ‘potentially getting married/civil exempt transfers’ or PETs). partnered, £2,500 if it is But, if you die within seven your grandchild, and years of making any gifts, £1,000 for anybody else. they are reassessed as if they had been taxable after ● Gifts for the upkeep of all. This may push up the tax your family, including for bill on the things you leave example, your children, when you die. If you don’t husband, wife, civil die within seven years, partner, or ex-husband/ you’re home free. wife/civil partner, but not an unmarried partner. www.advicenow.org.uk/livingtogether • Living Together & Inheritance Tax 3 ● All gifts to UK- Reliefs established charities, John’s Story housing associations, or There are also ‘reliefs’ which amateur sports clubs. reduce the amount of tax you “I’ve been living with have to pay on certain things: Gillian since the early ● Gifts to political parties 70s and we have three (generally those ● Business Property Relief children together. represented in parliament (BPR) – if you own We never got married, with at least 2 MPs). property, machinery or partly because we other assets used for a didn’t want the state to ● The gifts you make out business, the value of be involved in our of your income on a them can be reduced by personal life, and regular basis. For 50 or 100% when working we’ve always been example, if you pay out Inheritance Tax. very happy with the maintenance to a former This includes a 100% situation. But now we unmarried partner, or if reduction in the value of have hit a problem. you give your brother gifts of unincorporated Our home in north £100 every month, that businesses and unquoted London is worth quite a won’t be counted. It can shares (which includes lot of money. If one of also include premiums for AIM shares), though there us died, the other would life insurance that will are some restrictions on have to pay a huge benefit someone else. qualifying business. Inheritance Tax bill These payments have to and might have to sell be out of your income, not ● Forestry land – might our home. We’ve from your savings. also qualify for BPR or looked into all the APR. If not, the timber (but different ways of tax The spouse, charity, and not the land) might qualify political party exemptions planning but, because for a special woodland of our particular are also available when you relief. This is a complex die. This means you don’t circumstances, nothing area – get advice. will work for us. Our have to give your money away now, you could do it ● solicitor has advised us Agricultural Property in your will. that there is only one Relief (APR) – sometimes way of avoiding an called Farm Relief – If you Even if no exemptions apply, Inheritance Tax bill – own farmland that has most gifts you make before getting married! vacant possession (or can you die are tax-free at obtain it within 24 months) We never wanted the the time you make them the value of the land can be state to interfere in our because they are either discounted for Inheritance personal affairs and I PETs or fall within the Tax purposes. This also feel unhappy that it is nil-rate band. applies to farmhouses now. However, I’m a and cottages as long pragmatist. I could as they are used stay firm and not get for agricultural married but that would purposes. The hardly keep us warm value of other let when the tax bill lands agricultural land on the doormat.” and property can be reduced by 50%. 4 Living Together & Inheritance Tax • www.advicenow.org.uk/livingtogether Basic planning George and Harriet For many people, a little When he dies, George’s Inheritance Tax planning now assets add up to will substantially reduce the £340,000. He leaves bill your loved ones will get it all to his partner when you die. Others may be Harriet, who has to pay able to avoid one altogether. £6,000 in Inheritance Tax. Harriet has assets of her own of £100,000, so when she dies STEP 1 their children get an The first thing is to work out Inheritance Tax bill of realistically how much your £43,600. estate might add up to. If George had left say Add up everything you own, £200,000 of his estate including your share of the to his children and the things you own jointly with STEP 4 rest to Harriet, there your partner, and subtract Where possible, your best would still be £6,000 anything you owe. You need bet is to make use of the IHT on George’s death, to look at ways you can get potentially exempt transfer but none on Harriet’s rid of any amount over the rules. You could consider death, as her nil rate nil rate band (£325,000 for equalising your estate with band would cover her 2010–11) but, ideally still your partner’s (but unmarried estate. This would giving your money to the couples need to watch out have saved the family people you want it to go to. for other taxes, such as £43,600 because the capital gains tax, when assets wouldn’t have making gifts to each other), been “double charged”. or giving your heirs some of (See box on page 6.) Of STEP 2 the money now. Remember course this would only Think about where you want be possible if George that if you die within seven your assets to go – and knew that Harriet would years, these gifts will be make sure your will is up not need the assets counted as part of your to date. during her lifetime. estate for Inheritance Tax purposes unless they count as tax-free gifts – the £3,000 STEP 3 annual exemption, gifts on a Of course, practicalities must marriage, and expenditure be the first consideration – You need to get as many out of income exemptions there may be no one else assets outside your estate as can let you give away some that George wants to give his possible. Make sure that any useful sums. money to, and Harriet may death benefits – perhaps need all of George’s funds. In there would be some from which case, it would have an employer’s pension or been a good idea to even up insurance scheme – are not STEP 5 their estates before George included in the estate. You Ensure you make full use of died by giving Harriet some of can do this by nominating the nil rate band that his money. Be careful – you who it should be paid to. everyone has available can be liable for Capital Gains (£325,000 for 2010–11). Tax, Pre-Owned Assets Tax and/or Stamp Duty on gifts between unmarried couples. Get advice. www.advicenow.org.uk/livingtogether • Living Together & Inheritance Tax 5 Double charging STEP 6 STEP 7 and double Consider paying regularly You could consider investing into a life insurance policy in business or agricultural standards that is written to pay out on property as well. However Married couples and death to your partner (not this can be risky. You should civil partners are not your estate), so that they will take expert advice. double charged in this have enough to pay any way, only unmarried Inheritance Tax bill that does couples. Rather than occur. The premiums (which each partner having an count as gifts) will be exempt allowance of £325,000 from Inheritance Tax if they each (2010–11), fall within your regular gifts married couples and out of income exemption or civil partners £3,000 annual exemption. effectively have an allowance of £650,000 between them (2010–11). They can put off using part or all of this joint allowance until the second of them dies. Unmarried couples do not have this flexibility – if they want to make full use of their allowances, they must use each allowance at the time of each death. It’s not too late If you don’t manage to do any Inheritance Tax planning before your partner dies, all is not necessarily lost. You might still be able to reduce the overall Inheritance Tax bill by giving up part or all of whatever you are entitled to in favour of someone else. To do this, you’d need to enter into a ‘deed of variation’ (or, possibly, make a ‘disclaimer’) within two years of the death. You should speak to a specialist solicitor or tax adviser about this. George and Harriet By signing a ‘deed of variation’ on George’s death, Harriet could have arranged for £200,000 of his estate to pass directly to their children in spite of what it said in George’s will. This would have avoided the ‘double charge’. 6 Living Together & Inheritance Tax • www.advicenow.org.uk/livingtogether The problem of the family home For most people, their main of your house to your asset is their home. Even a partner, which would be a fairly modest house or flat in real problem if you split up. expensive areas like London or the South East can push If you do pass half your you over the Inheritance Tax home to your partner, you nil rate band. would not normally have to pay any Capital Gains Tax Giving your home away because it is his or her main during your lifetime, to your home. But there may be children for example, is Stamp Duty Land Tax to pay. unlikely to be a cracking idea. Having security should If you do this, you will need always be your biggest to take steps to avoid the concern. And although you “gift with reservation of probably trust the person benefit” rules. In practice, you would give it to, you can do this by something could happen that continuing to pay your full Leaving half the was beyond their control – share of the running costs of the home, and the cost home to someone leaving you homeless. of maintenance and else If you give the house away improvements – and keep Most couples tend to own but continue living there, it records to prove to HMRC their homes as joint tenants. will still count as yours when that you did. Changing to tenants in they tot up the Inheritance common is sometimes a Tax bill unless you pay rent Do you own your good idea as it opens up the to the owner at the commercial rate (or if the home jointly? possibility of leaving half the house to the children. new owner lives there with There are two ways to However, it is important to you, you pay at least your own property jointly, and stress that this can be a share of the home-related which you choose makes a really bad plan – it could expenses). This is because it big difference when one of result in the family home will otherwise be counted as you dies. being half-owned by your a “gift with reservation of partner, and half-owned by benefit”. If you are elderly or ● Joint ownership – when children who have moved infirm, these rules may not one owner dies their share away. This can, and does, apply – get specialist advice. of the property sometimes cause serious automatically passes to problems, both legal and Do you own your the other joint owner (but emotional, as your children that share still counts as home in one person’s part of the dead partner’s and partner could fall out, name? or the children could try to estate for tax purposes). force a sale. It is also If you do, then, depending ● important to remember that, Tenants in common – on what else you each own, if it is not the children’s each joint owner has their you might want to think main residence, the increase own separate share of the about putting it into both in the value of their half property which can be left names. You must get legal since your death will be to whoever they like. and financial advice about subject to Capital Gains this however, as you would Tax anyway. essentially be giving half www.advicenow.org.uk/livingtogether • Living Together & Inheritance Tax 7 Some people consider Giving your home To give or not reducing the value of their away to give? property through various There are planning schemes means. Iris gave her holiday that try to get around the cottage in Devon to If you have a mortgage, the ‘gift with reservation of her children in January amount you still owe will be benefit’ rules, and enable the 2006. As it was her set against the value of the owners to seemingly give the second home, not her home. So, for people who property away and yet keep main residence she need more money during living there. These schemes had to pay Capital their lifetime, taking out a are usually now hit by the Gains Tax, even though lifetime mortgage is worth “pre-owned assets” charge, no cash changed looking into. (If you don’t which means you have to hands. need to free up money for pay income tax in some use during your lifetime, a circumstances. If you are Sadly Iris died in lifetime mortgage is not a contemplating something December 2008. good bet.) Normally you like this, you must get advice Because she died don’t pay any interest until from a properly qualified within seven years, the you no longer need the tax adviser. value of the property home (i.e. when you die or became taxable for move permanently into care), Inheritance Tax when you pay it all in a lump purposes, so it ended sum, along with the amount up being taxed twice. borrowed. Had she kept the property until she died, Another possible route is there would only have selling part or all of your been Inheritance Tax to home to a specialist pay. There is no company or insurer (this is Capital Gains Tax on called “home reversion”). what you leave in your On your death the home is estate when you die. sold, the company gets its share and the rest goes to your estate. The downside here is that you don’t benefit from any rise in value of the part you sold. Both types of scheme reduce the value of your estate. However, there are big drawbacks with these schemes (often called ‘equity release schemes’): the cost can be so high that it wipes out any tax savings, and they are only for people aged 60/65 and older. Do not consider doing this without expert advice. 8 Living Together & Inheritance Tax • www.advicenow.org.uk/livingtogether Are trusts the answer? Trusts (or settlements as they are often called), are sometimes seen as the solution to all tax problems – but, if that ever was the case, it is certainly not true now. The point of trusts is that they enable you to delay giving money or assets to the eventual owner, and allow you to have some control over how a gift is used. There are two main forms of trust, which are: ● Life interest or interest in possession – this gives Trusts and tax can get quite someone (or a group of complicated, and you Do you own people) the use of the should get advice on all trust asset or income for the implications as both assets abroad? life or for a defined period. types of trust can be hit by Many other countries Inheritance Tax, Income have some form of ● Discretionary trust – Tax, and Capital Gains Tax. death duties, so if you this gives the trustees Speak to a specialist. have assets in more the choice as to who gets You will need a solicitor to than one country you the income and capital, set up a trust. need to look into the and when. possible impact of all sets of tax rules. The most common reason Many countries also for trusts is because the have rules about who intended recipients are still can or must inherit children. In this way parents from you. Get advice or grandparents can put from a tax adviser. money into a trust (or leave it in a will to a trust) for them. That trust can dictate that the income can be used for the children’s upkeep and Is your main home outside the UK? otherwise saved and paid out, together with the capital, Or are you planning on retiring when the children reach a to the sun? certain age. You may still face a UK inheritance tax bill on all of your assets (whether those assets are based in the UK or abroad) if this is your home country or you have lived in the UK for 17 out of the last 20 tax years. The rules are complicated so, if you are in this position, you should seek advice. www.advicenow.org.uk/livingtogether • Living Together & Inheritance Tax 9 How to find an adviser You can get advice on If you are thinking of setting Inheritance Tax planning up a trust or writing a will, from a tax adviser or an you need to see a solicitor. accountant who specialises in tax. However, you do ● The Law Society. need to be careful when Search for their choosing as anyone can set members online at themselves up as a tax www.lawsociety.org.uk adviser or accountant, even if they have no qualifications or experience. Make sure you choose someone who belongs to a professional institute which requires them to have been trained and taken exams, have professional indemnity insurance, and have a complaints procedure. The two institutes on the right can tell you if an accountant or tax adviser is one of their members, but they cannot recommend one adviser over another. ● The Chartered Institute of Taxation can provide you with a list of tax advisers in your local area. Call 020 7340 0550 or 0844 579 6700 or search Further information for their members online at www.tax.org.uk HMRC www.hmrc.gov.uk ● Institute of Chartered Accountants in England Low Incomes Tax Reform Group and Wales. Search for www.litrg.org.uk their members online at www.icaew.co.uk or call Which? Essential Guide – 020 7920 8100. ‘Giving and inheriting’ by Jonquil Lowe. ● Society of Trust and Estate Practitioners. You can buy it online at www.which.co.uk Search for members online at www.step.org or call 020 7340 0500. 10 Living Together & Inheritance Tax • www.advicenow.org.uk/livingtogether Jargon buster The jargon What it means Assets Things of value (house, savings, shares, car, antique gold necklaces, etc.) that you own. Beneficiary Someone who gets something from your estate. Capital Gains Tax A type of tax that you have to pay when you sell or give away an asset that has increased in value while you have owned it. It does not apply to gifts of cash or (usually) the sale of your own home. See ‘Further information’ on page 10. Domicile The country where the law treats you as having your real home. See page 9. Estate All the assets that you own when you die, minus all the debts you owe and other expenses such as funeral costs. Executor The person you appoint in your will to sort out your estate. Exemptions The ways you can give money to particular people without having to pay Inheritance Tax on it. Gift with Something that you give away, but continue to have the right to use reservation yourself. Anything deemed a ‘gift with reservation of benefit’ will still of benefit be seen as part of your estate when you die. (The person you give it to may also have to pay Capital Gains Tax when they sell it or give it away.) Intestate Dying without having made a will. See our Wills & Living Together guide. Nil rate band This is the amount below which no Inheritance Tax is charged. In tax year 2010–11 it is £325,000. Pre-owned Yearly income tax on the benefit you are deemed to get from things assets tax you give away but still retain the benefit of – for example, a house that you continue living in. Potentially exempt Gifts you make during your lifetime that become tax-free if you don’t transfer (PET) die for seven years. See page 3. (continued) www.advicenow.org.uk/livingtogether • Living Together & Inheritance Tax 11 (continued) The jargon What it means Probate The legal ability of the executors of your will to distribute your estate. Reliefs Rules which reduce the amount of tax you have to pay. The full value of certain assets is not counted. Taper relief This reduces the amount of Inheritance Tax the recipient has to pay on a gift you made to them between three and seven years before your death. Transfers of value Things of value that you give to somebody else; gifts. Trusts Property held by one person, or a group, for the benefit of another. For more about trusts see page 9. 12 Living Together & Inheritance Tax • www.advicenow.org.uk/livingtogether This leaflet is one of a series produced by Advicenow’s LivingTogether campaign. Other titles in the series include: ● Living Together Agreements ● Benefits & LivingTogether ● Housing & LivingTogether ● What about the kids? ● How to get Parental Responsibility ● Wills & LivingTogether for your partner’s children ● Pensions & LivingTogether ● Breaking up checklist The LivingTogether Campaign applies to England and Wales only. The law in Scotland and Northern Ireland is significantly different. The law is complicated and everyone’s situation is different. Always get advice. The LivingTogether campaign aims to increase awareness and understanding of the legal issues around living together. We explain exactly what rights couples living together really have, and show you practical ways you can protect yourself and your partner. The LivingTogether campaign is led by Advice Services Alliance in partnership with One Plus One (www.oneplusone.org.uk) and is funded by the Ministry of Justice. Advice Services Alliance (ASA) is the co-ordinating body for UK advice services. ASA members include AdviceUK, Age UK, Citizens Advice, DIAL UK, Law Centres Federation, Shelter and Youth Access. ASA works with its membership and government to develop policy on delivery of legal and advice services; champions the development of high quality information, advice and legal services; and provides supporting services to advice networks. Written by Mary Webber. With thanks to John Whiting, Tax Partner at PricewaterhouseCoopers, Jonquil Lowe, and The Low Income Tax Reform Group, for their assistance. Updated May 2010. Published by Advice Services Alliance, 6th Floor, 63 St Mary Axe, London EC3A 8AA. The Advice Services Alliance is a company limited by guarantee, registered in England and Wales no. 3533317. Charity no. 1112627. Registered office: 6th Floor, 63 St Mary Axe, London EC3A 8AA.