Welcome to our guide to inheritance tax. Whether you're planning for what will happen after you pass away, or you think you may be due for an inheritance one day, it's a good idea to know about inheritance tax. While only a small proportion of estates in the UK are currently liable for inheritance tax, that number is growing steadily. In this article, we'll share everything you need to know about inheritance tax, including current inheritance tax rates, threshold boundaries, and ways you can potentially reduce your inheritance tax liability. Let's get started.
Inheritance tax (abbreviated to IHT) is a tax applied to a person's estate after they pass away. Your estate is the combined value of your savings, property, other possessions and pension funds. The current inheritance tax rate is 40%
To be liable for inheritance tax, your estate must be worth over a specific threshold (currently £325,000) and you're only charged on the value of your estate over that threshold. There are also various exemptions and ways you can make your threshold higher.
Inheritance tax is quite a controversial subject. Its opponents believe it is unfair as people will have already paid tax on their income, and when they acquired their property. On the other hand, it gives the state inheritance tax money, which it can spend for the benefit of society.
Inheritance tax is charged at 40%.
It is only charged on the value of your estate over the threshold.
The standard threshold for inheritance tax is currently £325,000.
If you leave your home to your children or grandchildren, this number rises to £500,000 (if the property is worth less than £2 million). This £500,000 is made up of the standard £325,000, with an extra £175,000 tax free allowance added. This allowance is called the Residence Nil-Rate Band, or RNIB.
Let's bring that to life with some examples.
If you're married or in a civil partnership, and the value of your estate comes in below the threshold, you can transfer your unused value to your spouse or civil partner, which means they'll pay less inheritance tax when they pass away. If you transfer the whole threshold, the surviving spouse's allowance effectively becomes £650,000.
Rather than having all your beneficiaries pay inheritance tax on their inherited assets separately, it will be paid from one account.
The government runs the Direct Payment Scheme (or DPS), where you can nominate a bank account from which your inheritance taxes can be paid.
If the person who has passed away made a will, one of the executor's jobs is to deal with IHT. If there is no will, the person chosen to administrate your estate will pay the inheritance tax.
After the inheritance taxes are paid, the estate can be divided up as specified by the will or through probate.
If you pass away before your spouse or civil partner, you can leave all your assets to them and they will pay no inheritance tax. This includes money from property.
You can also pass unused threshold value to your spouse or civil partner.
However, when the surviving spouse or civil partner finally passes away, it's likely they will have to pay inheritance tax on their estate.
HMRC requires inheritance tax to be paid by the last day of the sixth month after the person passes away. Any outstanding inheritance taxes not paid after this period will incur interest.
You can choose to pay in instalments for up to ten years after the date of their passing, but this will also incur interest. In some situations, such as when there's a property that you need to sell, this may be the only option. When the property is eventually sold, the IHT and interest must be settled using the sale proceeds.
Even if your executor hasn't finished valuing the estate within six months of the person passing away, it's possible to pay some of the inheritance tax on account. This reduces the amount of interest you'll have to pay, and HMRC will refund your estate if they have overpaid.
Your beneficiaries only inherit your assets after inheritance tax has been paid, so a lot of the time, there will be no more to pay after that.
However, depending on the nature of their inheritance, there could be other charges they'll need to settle further down the line:
To find out what parts of an inheritance may be taxable (or for any taxation advice), it's always worth speaking to a solicitor or tax advisor.
The simplest way to value an estate is to calculate:
You may also have to consider the value of any gifts given during the seven years prior to the person's death, as they may be taxable.
There are also exemptions, including charity donations and smaller gifts to loved ones. If you leave your estate to your spouse or civil partner, you don't pay IHT at this time.
Costs levied after the passing, such as solicitor's fees and probate costs, do not come out of the estate's value before IHT.
It's advisable to keep records of how you calculate this value, as HMRC can select you for an audit up to 20 years after the IHT is paid.
Valuing an estate can be one of the most complex parts of the administration when someone passes away. It's always the best option to get advice from a solicitor and ensure everything's right.
When you inherit non-property assets from your parents, you can keep up to £325,000 without paying any inheritance taxes.
When there's property involved, your allowance increases to £500,000, as you can see below.
If you inherit a property from your parents, whether or not you need to pay inheritance tax depends on its value.
When you inherit a property from your parents, you get the £175,000 RNIB tax free allowance added to the standard £325,000 threshold, making your total allowance £500,000.
If the home you inherit is worth more than £175,000, you will pay 40% IHT on the value of the estate above the £500,000 threshold.
During your lifetime, you can take steps to ensure you pay a lower amount of inheritance tax than you might under other circumstances. These could include:
Each of these steps must be done in accordance with the law, so it's always advisable to speak to a specialist solicitor before you start moving money around.
Hidden in the detail of inheritance tax rules, there are several reliefs and exemptions which may be relevant to you.
Some types of property may offer lower inheritance tax rates, including agricultural land and business properties.
Some material assets may not count towards the value of your estate before IHT is levied. These include wedding gifts. Charitable donations given during your lifetime or specified in your will may also be exempt.
You can gift as much money as you wish to your children while you're alive. However, to do it in a way that doesn't incur inheritance tax requires thorough planning.
The maximum amount of money or assets you can give away each tax year without it being considered part of your estate if you passed away is £3,000.
The £3,000 figure is your total annual exemption, meaning you can give it all to one person or split that amount between a number of different people.
If you don't use your entire £3,000 allowance during a tax year, you can carry the unused amount forward to the next tax year.
When the value of your gifts exceeds your £3,000 allowance, the '7 year rule' comes into play to determine whether it can be exempt from inheritance tax.
Because gifting can be complex, you should always keep records of who you gave gifts to, the date you gave them, and their value.
If you live for 7 years after giving a gift, the value of that gift (however much it is) will no longer be considered as part of your estate, and no longer be liable for inheritance tax.
That's the 7 year rule.
If you unfortunately pass away during the 7 year period since you gave the gift, the amount of tax charged depends on how long ago you gave it. This amount is determined using a sliding scale called 'taper relief'.
Taper relief only applies if the total value of the gifts given during the 7 years prior to your passing, when added to your estate value, exceeds the £325,000 threshold.
Gifting money to charity while you're alive - or leaving a legacy to charity in your will - is exempt from inheritance tax.
The aim of this rule is to encourage more people to give to good causes.
If you give more than 10% of the net value of your estate to charity, your IHT percentage can decrease from 40% to 36%, potentially saving a significant amount of money for your estate.
The net value of your estate is the value remaining after all reliefs (including your standard £325,000 threshold allocation) have been deducted.
One of the benefits of taking out life insurance is that you can use it to pay your inheritance tax if you pass away and the policy pays out. However, to make the most of this advantage, it's essential that you get your life insurance policy written 'in trust'.
When you do this, your policy payout is not considered part of your estate, and therefore, not subject to IHT. Instead of going to your estate, the payout goes to your beneficiaries. They can then use this money to pay off your remaining inheritance tax bill.
Whether you choose a whole of life insurance policy or a standard term insurance plan, getting life insurance can reduce the financial burden on your loved ones after you pass away.
As always, talk to your insurance broker to get the best life insurance policy for your needs, and ensure that it's correctly written in trust.
To avoid problems with inheritance tax (and many other matters) after you pass away, it's essential that you make a will.
Making a will can ensure you take advantage of the several inheritance tax reliefs and exemptions if you want to, including leaving your whole estate to your spouse or civil partner, or leaving a legacy to a charity. You can also appoint a trusted person to be your executor, which includes administrating your inheritance tax.
If you don't make a will, you may miss out on these ways of being more inheritance tax efficient. It also makes the process of sorting out your finances after you pass away much slower, putting more stress on your loved ones at an already difficult time.
Talk to a specialist probate solicitor about making a will and keep your inheritance tax liabilities in mind.
Disclaimer: This information is general and what is best for you will depend on your personal circumstances. Please speak with a financial adviser or do your own research before making a decision.
Mike is a personal finance copywriter who has written for numerous financial services publications and websites over many years.
If the value of your estate when you pass away is less than the standard threshold rate - currently £325,000 - you do not pay anything in inheritance taxes.
If you leave your entire estate to your spouse or civil partner, or a charity, you also pay no inheritance taxes.
The standard inheritance tax rate is 40%, charged on everything above your threshold. However, there are several exceptions to this percentage and the thresholds.
Most of the time, the person the deceased person nominated to be the executor of their will pays inheritance taxes rather than the beneficiaries.
This is because IHT is generally calculated and paid before the assets are distributed to the beneficiaries.
However, the nature of the assets you inherit may require you to pay other taxes, such as income tax or capital gains tax.
You can increase your IHT tax free amount from £325,000 to £500,000 if you leave it to your children or grandchildren. This definition also includes adopted children, foster children and stepchildren.
However, you can only increase your tax free amount in this way if your estate is worth below £2 million.
You can. However, if you pass away within seven years of giving away your property, it could be subject to inheritance taxes, depending on its value.
If you pass on your property but you carry on living there, you'll need to:
If you don't fulfil these obligations, the gift will be considered a 'gift with reservation' and no longer exempt from inheritance taxes.
A gift (that would not be subject to inheritance taxes if you fulfil the 7 year rule) could include:
You have an allowance of £3,000 each tax year that you can give away as gifts without being subject to inheritance taxes if you pass away.
You can give it all to one person or split it between multiple beneficiaries.
Some gifts are exempt from this calculation, including:
To make the inheritance tax process run more smoothly after you pass away, you should certainly consider:
You should also make sure you get specialist advice when you make big financial changes in your life, or change your will.
If your estate owes inheritance tax, your executor must start paying it before the last day of the sixth month after you have passed away.
