Inheritance Tax laws are extremely complicated, which means many people are unsure whether they’ll end up leaving a tax bill for loved ones when they die.

In 2018, the Office for Tax Simplification published findings on how the current Inheritance Tax system could be overhauled and simplified.

At the moment, the Inheritance Tax system is confusing, to say the least. You can give away some money while you’re alive, or give away a lot more and live for at least seven years after you’ve done this, and there will be no Inheritance Tax to pay.

You can also leave money up to a certain value, or leave whatever you want to your husband, wife or civil partner, without Inheritance Tax being an issue.

In this article, we explain how some aspects of Inheritance Tax work, and how the Office for Tax Simplification has suggested they could be improved.

How Inheritance Tax could be simplified

The main recommendation by the Office for Tax Simplification, is that the rules on what you can give away while you’re alive are simplified. It recommends:

  • Doing away with the current limits on the amount you can give away in a 12-month period, along with money you can give away when someone gets married or enters a civil partnership. These should be replaced by a straightforward 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 allowance should be set at.

  • Reconsidering the so-called ‘small gifts allowance’. Under the current rules, you can give away £250 to as many people as you like, and there’s no Inheritance Tax to pay.

  • Simplifying the rules on what’s called ‘gifts from normal expenditure out of income’. This is a little-known allowance which can only be used by some people. It lets you give away money that’s from your income (so, salary, earnings, rental income 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.

  • 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. The Office for Tax Simplification says that this should be reduced to five years.

  • Abolishing what’s called ‘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.

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The nil rate band explained

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. 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). But unlike couples who live together, married couples or those in a civil partnership can also transfer any unused allowance after death.

It’s not actually the couple who transfer the allowance to each other. Those who sort out the financial affairs of the person who’s died make the transfer after the surviving spouse or civil partner has died.

Giving money to your children while you’re alive

Under the current system, if you give money to 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. And the nil rate band is applied in the order the gifts were made.

The report says that Inheritance Tax on lifetime gifts should either be paid by the estate or that Inheritance Tax on lifetime gifts shouldn’t be charged on the basis of the order that the money was given.

Read more about how gifts are impacted by Inheritance Tax in our articles Which gifts are exempt from Inheritance Tax? and Inheritance tax: what are potentially exempt transfers?

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.

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.

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Which? provide an easy and affordable way to write your will and ensure the people you care about are looked after when you’re gone. You can even get your will reviewed by their specialists to make sure it’s completed correctly.

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Will these recommendations become reality?

Inheritance Tax has not been a major subject in the government’s recent Budgets, outside of the nil-rate band being frozen at the current rate until 2028. So it seems unlikely that the Office for Tax Simplification’s proposals will become law anytime soon.

In the meantime, however, if you know the value of your estate is likely to exceed the current £325,000 Inheritance Tax threshold, it makes sense to consider using current allowances which could help you reduce any potential liability. You can read more about these in our article Understanding Inheritance Tax. To learn more about how you can keep Inheritance Tax bills down, read our article Six ways to reduce Inheritance Tax bills.

Remember that tax rules can be complicated, so you should seek professional financial advice if you’re looking for specific recommendations based on your individual circumstances You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you.

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