Should the inheritance tax system be simplified?


    The Office of Tax Simplification (OTS) has called for inheritance tax rules to be simplified, making end-of-life planning easier for those wanting to pass on money, possessions or property. Its suggestions were made as part of a review of inheritance tax regulation requested by former Chancellor Phillip Hammond.

    Current rules stipulate that if a person dies within seven years of gifting or passing on assets to a child or other direct descendent, a tax of up to 40% must be levied on the gift. The OTS has suggested that this limit should be lowered to five years, and that inheritance tax regulation in general should be simplified to help reduce confusion for those planning later life.

    Rather than having several complicated rules around gifting, the OTS has suggested that one “personal gifting allowance” be created. It also pointed out that the £3,000 annual exemption created in 1981 has not risen with inflation; that allowance would be worth £11,900 today.

    The organisation criticised the legislation that means inheritance tax is levied on lifetime gifts made to a trust. It also suggested that the tax on death benefit payments made from life insurance be scrapped.

    When does inheritance tax apply?
    Inheritance tax applies to anyone leaving an estate above a threshold of £325,000. The amount taxed is usually 40% of the value of the estate above the threshold. This current threshold is fixed until the 2020-2021 financial year and will be based on consumer price inflation thereafter.

    If you are leaving your main residential home to your children or other direct descendants, there is a nil rate band of £100,000. If you are leaving 10% or more of your estate to charity, inheritance tax rate is lowered to 36%.

    Assets left to a spouse or civil partner are normally exempt from inheritance tax. If you leave everything above the threshold to a charity or to a community amateur sports club, this will also be exempt. Inheritance tax also applies to gifts given in the seven-year period before your death. The tax on gifts is levied on a sliding scale, according to when the assets were given in relation to your death.

    Find out more about inheritance tax on gifts

    How can you prepare for inheritance tax and gifting in later life?

    1. Think about informing your next of kin and gift recipients
    The executor of your will, or the person handling your estate after your death, will use funds from your estate to pay inheritance tax to HM Revenue and Customs (HMRC).

    Though tax is not normally paid by your beneficiaries on the assets they inherit, they should be informed of any plans you have for your estate.

    In most cases, if you give gifts to anyone before your death, they will have to pay inheritance tax if you die within seven years of the gift being given, and if the sum is greater than £325,000.

    You might want to think about speaking with your next of kin and any gift recipients to alert them of any financial responsibilities they may have after your death.

    2. Consider establishing a trust
    If you’d like to leave part of your estate for a specific purpose, you could leave money, property or investments in a trust for your spouse or your adult children. This trust could be used to pay for education or for financial support for living costs.

    If you decide to establish a trust during your lifetime, this might incur capital gains tax. However, if you set up the trust as part of your will, this would not apply.

    Some trusts are subject to further trust taxes, or inheritance tax, depending on the type. Trustees could have to pay income tax at a rate of 45%, and capital gains tax at 28%. You may want to speak with an expert to work out whether this is best for your needs.

    3. Think about life insurance
    If you’d like to prepare for any inheritance tax costs after your death, you may wish to take out a life insurance policy. Any life insurance payout added to your estate will increase the amount of inheritance tax owed, so it might be worth organising this payout to go into a trust.

    Find out more about inheritance tax regulations

    4. Call the inheritance tax helpline for advice
    If you’re planning your later life and would like further advice on inheritance tax or gifting, HMRC’s Inheritance Tax and Probate Helpline can help you. The helpline can talk you through your responsibilities and the completion of any relevant forms.

    If you are leaving farmland or woodland in your estate, there are additional regulations around agricultural relief; the helpline can also advise you on this.

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