As the old proverb says, nothing in this world is certain, except death and taxes. Inheritance tax (IHT) fittingly relates to both. IHT is a complex tax, but with some planning there are ways you can reduce your bill. Careful financial planning could save your beneficiaries a lot of unnecessary grief and heartache.
We’ve put together the most frequently asked questions to help you understand the basic framework of IHT. You may wish to seek advice regarding inheritance tax, especially if you have a large estate, or if as an heir you find yourself in any kind of dispute.
What is inheritance tax?
Inheritance tax is a tax on money or possessions (including property) you leave behind when you die. It’s essentially a tax on your estate.
What is your estate?
Your estate is everything you own that is worth money. It’s your net worth. That includes your bank accounts, your home, your car, land, jewellery and any other smaller assets. It also includes any rights or licenses you may have (such as rights to a song you wrote).
How do you value the estate?
List all the assets and work out their value. Deduct any debts and liabilities (such as outstanding mortgage, loans, plus funeral expenses). If you are valuing the estate of someone who has died you will need to keep the records of how you worked it out. HMRC can ask to see records for up to 20 years after IHT is paid.
What is the current inheritance tax rate?
The current inheritance tax rate is 40 per cent. It’s only charged on the part of your estate that’s above the threshold. There is no tax to be paid if the value of your estate is below the IHT threshold. The IHT rate is cut to 36 per cent if you give away 10 per cent of your estate to charity. You can find everything you need to know about IHT and how to report it on the gov.uk website.
What is the current IHT threshold?
The current threshold for inheritance tax is £325,000. If your estate is worth £500,000, inheritance tax will be charged on £175,000 (£500,000 – £325,000). At the current tax rate of 40 per cent, this means the inheritance tax payable would be £70,000 (40 % of £175,000).
What is the Nil Rate Band?
If your estate is valued below the nil rate band (NRB) of £325,000, then you won’t have to pay any inheritance tax. The NRB is fixed at £325,000 until 2021.
What is the Residence Nil Rate Band?
The residence nil rate band (RNRB), also known as the home allowance, was introduced in April 2017. This allowance is on top of the nil rate band, and is eligible for those passing on homes (or a share of it) to children or grandchildren (that includes step-children, adopted children and foster children).
The home allowance is currently £100,000, rising to £175,000 by April 2020. This means if you pass on your home to your children, the amount you can pass on before you pay inheritance tax is £425,000.
Who pays the tax?
Funds from your estate are used to pay inheritance tax. This is done by the person dealing with your estate, normally the executor of your will (if you have one). If you don’t have a will, it’s the administrator of the will who does this.
How soon after someone passes away does IHT need to be paid?
Inheritance tax should be paid within six months after the person’s death. If tax is paid after six months, HMRC (Inland Revenue) will start charging interest on tax not paid within the six-month time frame.
How can I reduce the amount of inheritance tax?
Reducing the amount of IHT due on an estate is complicated. The main way to avoid inheritance tax is to spend your money while you are alive or give it away, but gifts will be subject to IHT if made within 7 years of your death. You can reduce the amount by:
- Leaving your estate to a spouse or civil partner.
- Making use of tax-free gifts while you are still alive. You can regularly give away up to £3,000 a year in gifts, but people you give gifts to in the seven years before your death will be charged inheritance tax if your estate is worth more than £325,000.
- Putting life insurance policies under trust.
- Paying into a pension rather than a savings account.
- Putting assets into a trust for heirs.
- Leaving money to charity.
Are the inheritance tax rules different for married couples and civil partners?
Married couples and civil partners can pass their possessions and assets to each other tax-free. Surviving partners can then use both tax allowances, so when they die they can pass on up to £650,000 in 2017/18 or up to £850,000 if the estate includes their home.
Never take steps that leave you struggling while you are alive in order to save tax after you’ve died. And be sure to make a will to protect your beneficiaries’ interests.