How Much Inheritance Tax Do I Have to Pay?
Inheritance tax (IHT) is a tax on the property, money and possessions—also known as the estate—of someone who has died. Certain gifts made during a person’s lifetime may also be taxed, depending on who received the gift, its value and when it was given.
Why Do I Have to Pay Inheritance Tax?
The argument in favour of IHT is that it redistributes inherited wealth for the benefit of all and tries to discourage too much wealth being locked up within families. The argument against it is that taxes are often paid when the inherited money was originally accrued, so taxing it again is unfair.
Whatever your opinion and political views, inheritance tax is a financial reality. So it makes sense to know how it will affect you and what steps you can take to soften the blow.
How Much Inheritance Can I Leave without Paying a Tax?
The amount owed on an inheritance depends on the estate’s total chargeable value. Normally, no tax is levied if:
- The estate is worth less than the nil rate band of £325,000 (and there have not been unrelieved gifts in the 7 years before death).
- The estate goes to a spouse, civil partner or exempt beneficiary such as a charity, even if it’s worth over £325,000.
If neither of these situations applies, everything valued above £325,000 is taxed at 40 per cent, or a bit lower if at least 10 per cent of the estate’s net baseline value is left to charity. The tax-free threshold may be £500,000 or even £1 million in some situations, such as when inheriting a house from the survivor of married parents. You’ll find more on this below.
How are Gifts Taxed?
Most gifts made more than seven years before death escape inheritance tax (providing that they were genuine gifts and there was no ‘reservation of benefit’). However, if the deceased person gave away unrelieved gifts exceeding £325,000 within seven years of passing away, any gifts above this threshold are taxed on a sliding scale up to 40 per cent. The amount of tax due after death is based on the “seven-year rule,” which looks like this:
- Gifts given 0 to 3 years before death: 40 per cent tax rate
- 3 to 4 years: 32 per cent
- 4 to 5 years: 24 per cent
- 5 to 6 years: 16 per cent
- 6 to 7 years: 8 per cent
- 7 or more years: 0 per cent
What Reliefs and Exemptions Exist for Inheritance Tax?
Use this quick summary to help you understand if you are exempt from paying IHT:
- Assets left to a spouse or civil partner are exempt from inheritance tax, provided the spouse or partner is domiciled in the UK.
- People in risky roles are exempt from IHT if they die in active service or due to an on-the-job injury. Examples include military service members, police officers, firefighters, paramedics and humanitarian aid workers.
- Business Relief allows some business assets to be passed on free of IHT or at a reduced tax rate.
- Agricultural Relief may be available for people whose estates include a farm or woodland.
- Strategically giving away money in increments of £3,000 or less at least seven years before death can lower inheritance tax liability.
- Gifts made regularly from excess income are relieved from inheritance tax immediately and there is no upper limit to this save for the donor’s excess income.
When and How Do I Pay Inheritance Tax?
Funds from the estate typically pay IHT to HM Revenue and Customs (HMRC). The deceased’s whole-of-life insurance policy may be able to be used to pay IHT. Assuming there’s a Will, the person handling the estate, known as the executor, arranges to pay IHT. Otherwise, the administrator of the estate is responsible for this. However, IHT on received gifts is payable by the recipients of those gifts and tax on trusts is payable by the trustees.
If you owe IHT on any property you inherit or gifts you receive, you must report the value of the estate to the HMRC within 12 months of the person’s death. Download and complete form IHT400 and mail it to the address on the form. If you need help filling in the form, contact a probate professional.
You must pay inheritance tax by the last day of the sixth month after the person dies. So if they pass away in January, you have until 31 July to pay the tax. Missing this deadline could result in penalties and interest. Remember, you need an IHT reference number from HMRC at least three weeks before making a tax payment. You can apply for one online or by post using form IHT422.
Acceptable payment methods include:
- Approving a payment through your online bank account
- Making a bank transfer over the internet or telephone
- Paying at your bank or building society by cash or cheque
- Sending a cheque through the post
- Making a Direct Payment Scheme from the deceased’s bank account
- Covering the cost with British government stock
- Transferring national heritage property
- Paying inheritance tax in yearly instalments (eligible for certain assets that take time to sell, such as a house)
What If I Inherit My Parents’ House?
Property can pass between spouses and civil partners with no inheritance tax. However, as with other assets, when this passes to unrelieved recipients, it is charged to IHT. There is an additional nil rate band (the Residence Nil Rate Band) of up to £175,000, potentially taking the tax-free threshold to £500,000 (when including the £325,000 nil rate band) if a parent leaves a residence (or former residence) to their children (including adopted, foster or stepchildren) or grandchildren. This can include a property that is not a residence at death, providing the parent lived in it as their home at some point during their life.
Still, there are some rules you should know:
- The Residence Nil Rate Band applies in full only if the total estate is worth less than £2 million.
- If the estate is worth more than £2 million, the property allowance decreases by £1 for every £2 the estate’s worth exceeds £2 million.
- Homes held in a discretionary trust do not qualify for the £175,000 property allowance, even if the beneficiaries are the estate holder’s children or grandchildren.
If your parents give you their house whilst they’re still alive and whilst this may be a gift for various taxes, there are some ‘anti-avoidance’ measures that often prevent this from being effective for IHT. If your parents continue living in the property after giving it to you, it could be considered a “gift with reservation of benefit,” meaning they still benefit from it. In this case, the property counts toward the total estate value and can actually be worse overall from a tax perspective. There are some ways in which this can be avoided that may include the following but there is a bit of a minefield of rules around this and specialist advice is generally required.
- Paying rent equal to the full commercial rate for the property can ensure that there is no reserved benefit.
- Additionally, if your parent lives in the property and shares it with you whilst you also live there, with you each paying you own proportions of the bills and you continue to live in the property until your parent’s death then this can also ensure that the original gift was effective for inheritance tax.
If your parents pass away within seven years of giving their house to you, it’s treated as a gift, and the seven-year rule applies.
How Does being Married or Unmarried Affect Inheritance Tax?
Estate transfers between married couples or civil partners are exempt from IHT (subject to domicile, as mentioned above). In addition, the deceased spouse’s nil rate band that they didn’t use (up to £325,000, plus up to £175,000 in the case of the Residence Nil Rate Band) are added to the living spouse’s allowances. This means a couple can jointly leave up to £1 million to their heirs, tax-free.
If you’re not married but own assets jointly with another person, things get complicated, especially where residential property is concerned. Whether you owe inheritance tax when your partner dies depends on if you own the property as “joint tenants” or “tenants in common.”
Being “joint tenants” means you both own the entire property. The house goes to you when your partner dies, but you’ll have to pay IHT . After that, you own the property outright.
Being “tenants in common” means you each own a percentage of the home. As long as your partner has a Will leaving their share to you, the inheritance tax would typically be paid out of the estate. You could also end up owing IHT, depending on the estate’s total value. Without a Will, your unmarried partner’s share goes to their surviving family. This is why it’s especially important to seek inheritance tax planning for unmarried couples if you own a property with someone who isn’t your legal relation.
How Do I Leave Money to Grandchildren in a Will in the UK?
Grandparents in the UK have three options for leaving money to children or grandchildren in a Will:
- Outright gifts are accessible to the recipient after the age of 18. If any grandchildren are younger than this when you die, the executor of your Will holds the money until they’re old enough.
- Age-contingent gifts allow you to set a higher age limit for the gift recipient, typically 21 or 25, to reduce the risk of squandering their inheritance.
- Discretionary trusts are managed by trustees, who have complete control over the capital and income of the trust. They can distribute the money to your children and grandchildren based on the instructions you give in a “letter of wishes” rather than at a legally required age.
With gifts to grandchildren, the rules for inheritance tax are a little different to gifts to children and further IHT may be payable to gifts held on trust for grandchildren.
Get Help Navigating Inheritance Tax Laws
The rules around IHT can be confusing. If you have a sizeable estate, getting financial advice about what happens to your money after you die is a sensible first step. The specialists at Parfitt Cresswell can help you make savvy financial decisions with inheritance tax implications in mind. Take advantage of a complimentary initial consultation with one of our legal experts—contact us today to request your appointment.
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