This might sound flippant but it is hugely relevant for anyone planning towards retirement, old age or the ultimate… demise.

What is inheritance tax?

Inheritance tax (IHT) is a tax on your estate that is owed within the first six months after your death. If you own your home, then it may be eligible for IHT depending on its value.

The standard rate for IHT is 40%, which is charged on any part of your estate that is above £325,000 (£650,000 for married couples). Estates valued above the threshold can escape IHT if the estate is left to a spouse, civil partner or a charity in your will.

Can you avoid inheritance tax?

Roy Jenkins, a former Chancellor of the Exchequer, described IHT as “a voluntary levy paid by those who distrust their heirs more than they like the Inland Revenue.” When Gordon Brown was Chancellor of the Exchequer, he also referred to IHT as ‘voluntary’ due to the many ways individuals can plan ahead and avoid paying IHT.

IHT is often referred to as a ‘voluntary tax’ as, depending on your circumstances, there are ways of planning ahead to avoid owing it. Always consult a solicitor (or financial adviser or an accountant) to discuss your circumstances, as there may be nothing you need to do or can do to avoid your family being hit with IHT. 

Gifting your house to your children

A common method of avoiding IHT is to gift your house to your children. The transfer of property must be completed more than seven years before you die to completely remove it from your legal estate. If you die within three years of gifting the property, it will be liable for the full 40% IHT. After the third year, the percentage IHT owed reduces by 8% annually until it reaches 0% after seven full years. This is referred to as the seven-year rule.

Once you have gifted your home, you and your children may decide that you will continue living there. In these instances, you must be paying rent on the property at a similar rate to comparable properties in the area, as well as paying bills. 

Living in a gifted home rent-free will leave the property liable for IHT. It’s important to note that once the property has been transferred to offspring, the original owner will no longer have any legal rights to the property. This can leave the individual in a vulnerable position if their children decide to sell the home or evict the occupant over a dispute. Both scenarios may seem unlikely but when undertaking a permanent transfer of property, it’s important to be aware of the potential risks involved.

For some people, keeping a home within the family is not a priority, so there’s little need to go through the process of gifting it. You may choose to sell the property and gift the money made from the sale to your children instead. The seven-year rule still applies to the gifted funds in this scenario, so bear that in mind.

Some property owners choose to gift their home to try to avoid care home fee assessments in later life. This is less than advisable since there is no seven-year rule in this instance. The council can look back almost indefinitely to see if you have owned property, adding the capital back in if they believe you gifted your home for this reason.

Residence Nil Rate Band relief

If you simply leave your home to your children in your will, the property remains part of your estate and therefore will be liable for IHT. 

However, IHT has a provision called Residence Nil Rate Band (RNRB), designed to reduce the tax burden for those who wish to pass their home to lineal descendants - children (including step-children, foster children and adopted children), grandchildren and great-grandchildren.

RNRB provides an extra threshold of £175,000 that can be claimed on top of the £325,000 IHT threshold, increasing the total threshold to £500,000. This is only available when the deceased was a taxpayer and the home is left to their lineal descendants in the will. Depending on the total worth of your estate, there may be little need to gift the property instead of leaving it in your will. 

Always seek legal advice

Whilst no one wants to think of their own demise, it is important to plan for the succession to your estate. 

Take great care over any idea of moving assets around to avoid tax. Many aspects must be dealt with well ahead of time, so seeking legal advice early on is always advised.

For all matters concerning your will and estate planning, consult a solicitor.