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Inheritance tax rules should be simplified

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A new report says that inheritance tax should be simplified. The Office of Tax Simplification says that the rules on money you can give away while you’re alive should be streamlined and easier to understand.

Inheritance tax – what happens now

Government figures show that each year almost 600,000 people die, and 275,000 people have to fill in an inheritance tax form for someone who’s died. But only 24,500 of those have any inheritance tax to pay.

At the moment, the inheritance tax system is complicated to say the least. You can give away some money while you’re alive and there will be no inheritance tax to pay. Or, you can give away whatever you want, and as long as you live for at least seven years after you’ve done this, there will be no inheritance tax to pay.

You can also leave money to family and friends, up to a certain value when you die (it’s called the ‘nil rate band’ or inheritance tax threshold) and there will be no inheritance tax to pay.  Or you can leave whatever you want to your husband, wife or civil partner, without inheritance tax being an issue.

SAVVY TIP: The inheritance tax threshold is set at £325,000 in the tax year 2019 – 20.

Inheritance tax should be simplified

The main recommendation by the Office of Tax Simplification is that the rules on what you can give away while you’re alive should be simplified.

It recommends:

  • Doing away with the current limits on the amount you can give away in a 12-month period. It also wants to simplify the rules on money you can give away when someone gets married or enters a civil partnership. The Office of Tax Simplification says that these limits should be replaced by a straightforward personal inheritance allowance. You’ll be able to give this amount away without having to pay inheritance tax. The report doesn’t recommend the level this personal inheritance allowance should be set at.

SAVVY TIP: Currently, you can give away up to £3,000 in any tax year and there’s no inheritance tax to pay.

  • Reconsidering the so-called ‘small gifts allowance’. Under the current rules, you can give away up to £250 to as many people as you like, and there’s no inheritance tax to pay.
  • Simplifying the rules on ‘gifts from normal expenditure out of income’. This is a little-known allowance which can be used by wealthier people. The rule lets you give away money that’s from your income (so, salary, earnings, rental income and/or bank interest). You can’t use this allowance to give someone a large lump sum (say, for a house deposit), but you could use it to give them money for their birthday, for example or to make regular payments.
  • Changing the period of time that you have to survive in order for money you’ve given away to be exempt from inheritance tax. At the moment, you have to live for seven years after you’ve given money away in order for it to be discounted for the purposes of inheritance tax. The Office of Tax Simplification says that this should be reduced to five years.
  • Abolishing ‘taper relief’. Taper relief basically means that the amount of inheritance tax that someone might owe, if they’ve given away money while they’re alive, reduces – or tapers – once they’ve lived for at least three years after the gift was made. Again, it’s something that many people aren’t aware of, and it further complicates an already complicated area.

Using the nil rate band

As outlined above, the nil rate band is the amount of money you can leave someone without there being any inheritance tax to pay.

  • If you’re single or you’re living with your partner, but aren’t married, you can each leave up to £325,000. You can leave money or assets worth up to £325,000 (in total) to each other, to your children and/or to other family members and friends.
  • If you’re married or in a civil partnership, you can leave as much as you want to each other. The nil rate band lets you leave £325,000 to anyone else (for example, your children).

SAVVY TIP: Unlike couples who live together, married couples or those in a civil partnership can also transfer any unused inheritance tax allowance (nil rate band) after death.

Who pays inheritance tax?

If you leave someone money in your will, it’s your ‘estate’ that pays inheritance tax. That means that HM Revenue and Customs gets paid before money you’ve left is distributed. However, it’s different if you give away money while you’re alive. Under the current system, if you give away money to – for example – your children while you’re alive, the nil rate band is applied in the order that any gifts are given.

So, if someone gives one of their children £250,000 one year and gives the other one £250,000 the following year, they could inherit different amounts. Why? Because the person receiving the gifts generally has to pay inheritance tax on them. So, most of the nil rate band would be used up on the first gift of £250,000, and there would only be £75,000 left over for the second gift. The other £175,000 would attract inheritance tax (at 40%) of £70,000. So one child would get £250,000, the other would get £180,000.

The report by the Office of Tax Simplification says that inheritance tax on lifetime gifts should either be paid by the estate or, if not, it shouldn’t be charged on the basis of the order that the money was given.

Life insurance policies

Another recommendation is that money from life insurance policies should be paid out without being liable for inheritance tax. At the moment, if you set up a life insurance policy, money that’s paid out when the policyholder dies is liable for inheritance tax. The only exception is if the life insurance policy is written ‘in trust’.

This is a bit frustrating, to put it mildly – not least because people often take out life insurance to pay an inheritance tax bill. The report recommends that payouts from ‘term life insurance’ (which is a life insurance policy that lasts for a specific term) should be free of inheritance tax.

Related articles:

How to leave money to charity in your will (and save tax)

How to make sure you get the new £1 million inheritance tax allowance for your home

How to find a will

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