Money
Retirement
Taming Inheritance Tax - part one
This six-part guide gives general advice only. It should not be relied upon for major decisions on property or tax. You should consult a qualified accountant, tax adviser or lawyer before taking action on the basis of the information in this guide, writes Paul Lewis
No one enjoys paying any tax. But Inheritance Tax, or IHT, seems to be hated more than most. People have worked hard for their money, their home or their property and they believe they should be free to pass them on to their heirs. The next generation often feels that the property of their parents - particularly the 'family' home - is somehow theirs and that taxing it is tantamount to theft, especially when the home has to be sold to pay the tax.
Despite these concerns, only a small minority of estates are actually liable to Inheritance Tax. In 2005/06 575,000 people died but only 37,000 estates had to pay IHT. That is 6.5% of those who died or 2 people out of every 31. In other words for 31 people who died in 2005/06 IHT was not an issue for 29 of them - though probably one of those 29 was exempt only because they were a spouse or civil partner and inherited the whole estate.
The anxiety about IHT is due to the fact that the number paying the tax is growing - this year just about double the number who paid it each year in the 1990s. The reason for that is simple: house prices. As they rocket, the threshold at which IHT begins rises more slowly and so more estates are brought above the limit at which the tax starts. If the IHT threshold had gone up in line with house prices it would now be £450,000 instead of the £285,000 set for 2006/07. That feels uncomfortably close to the average price of a home in the UK which is now almost £200,000. In parts of the country most homes are sold for more than £285.000.
Unpopular as it is, IHT is unlikely to be scrapped, or significantly reduced, in the near future. In 2005/06 it brought in around £3.3 billion for the Treasury and this year that is expected to rise to £3.6 billion. That is slightly more than would come from adding a penny on the basic rate of income tax or by raising VAT to 19%. Not changes any Chancellor would willingly make.
How it works
To see if your estate will be liable to Inheritance Tax when you die, add up the value of everything you own, including your house, any investments, savings, personal property, and the value of any life insurance policies which form part of your estate (see 'life insurance' below on how to avoid IHT on it). Then add on any gifts you have made in the past seven years (many of these may be exempt - see 'reducing the tax' below). Take away from this total any debts. They include a mortgage or equity release debt, any other loan secured on your home, any money you owe on credit cards, any personal loans or hire purchase agreements, and any unpaid bills, including any income tax you may owe. You can also deduct the reasonable costs of your funeral. Take away from this total anything you intend to leave to your spouse (or civil partner) or to charity. If the final amount is £285,000 or less then no tax will be due. If your total is more than that, it is likely that there will be IHT to pay.
The threshold of £285,000 applies for this tax year - 2006/07. The threshold for the next few years has already been announced - see Table 1. Strictly speaking the 'threshold' is called the 'nil rate band' because on that band of estate value the rate of tax is nil.
Table 1
Threshold for Inheritance Tax
2006/07 to 2009/10
2006/07 £285,000
2007/08 £300,000
2008/09 £312,000
2009/10 £325,000
The threshold normally changes on 6 April each year so the limit of £285,000 applies to deaths from 6 April 2006 to 5 April 2007.
The rate of IHT is 40% of the excess above the threshold. To work out the tax due subtract the threshold from the value of the estate and multiply the answer by 0.4. So this year the Inheritance Tax on an estate of £385,000 will be £385,000 - £285,000 = £100,000; £100,000 x 0.4 = £40,000. Table 2 gives some examples of the tax due on estates of various sizes.
Table 2
Tax due 2006/07
Estate value Tax due % of total
£285,000 £0 0%
£350,000 £26,000 7%
£400,000 £46,000 12%
£500,000 £86,000 17%
£570,000 £114,000 20%
£750,000 £186,000 25%
£1,000,000 £286,000 29%
£2,000,000 £686,000 34%
