When discussing with clients about Inheritance Tax (IHT) or Probate, there is one piece of taxation legislation that everybody seems to know being the £3,000 IHT annual allowance. In my opinion:
- Out of all the IHT tax reliefs available, this is the best known
- This is also one of the most misunderstood reliefs available
Facts
“I can give away £3,000 p.a. and this will be IHT free” – CORRECT
“I can receive £3,000 inheritance per annum as this will be tax free” – CORRECT
What is not known is:
“I can give away £1m p.a. and this will be IHT free” – CORRECT (but see below)
“I can receive £1m inheritance p.a. and this will be tax free” – CORRECT (but see below)
So what does the £3,000 exemption actually mean?
It goes back to the fundamental principle of IHT.
IHT is payable on:
The value of your estate on death
PLUS
The value of your lifetime gifts made in the previous 7 years
Therefore, providing you give the £1m to an individual or individuals (ie, not a trust or company) and live seven years, there will be no tax to pay, as it is not part of the IHT calculation.
All the £3,000 rule says is that when looking at the value of lifetime gifts in the previous 7 years, the first £3,000 given away is excluded.
Therefore, if somebody gives away £10,000 and died after 5 years, the value of lifetime gifts in the IHT computation for that year would be £7,000. Whether or not IHT is payable depends on the level of the estate and the relief available, such as the nil rate band, residential nil rate band and transfer of unused bands from spouses.
For most married couples with a residence and children, their IHT reliefs total £1m.
Therefore, if you give away £1m and die within 7 years, your lifetime gift within 7 years is £997,000.
In other words, the gift of £1m has only saved you IHT of £3,000 x 40% = £1,200, although there is some tapering if the gift was made more than 3 years before death.
The general recommendation to clients is therefore, if you are happy too, give away as much as you can, when you can.
This article is written by Barry Jefferd, Director of G H Probate Ltd. G H Probate Ltd is authorised by the Institute of Chartered Accountants to act in the reserved matter of non-contentious Probate. This article only contains general information and does not constitute advice.
