Inheritance Tax Explained
Are you wondering what the Inheritance Tax threshold is or how you can help your family avoid paying Inheritance Tax? Our guide tells you everything you need to know about Inheritance Tax and how you can potentially avoid it.
What is Inheritance Tax?
Inheritance Tax is a type of tax that’s paid when you inherit money or property from someone who has died. Inheritance Tax is charged on the estate of the deceased person which can include properties, savings and other assets after any debts have been deducted.
- What is an “Estate”?
- “Estate” is the word used for all the deceased’s belongings. It includes their money, investments, car, house, jewellery, clothes… everything they owned.
Who pays Inheritance Tax?
Whoever is inheriting the assets of the deceased will be required to pay Inheritance Tax. Usually, if there’s a will, the executor of the will is responsible for paying Inheritance Tax. The executor of the will is the person who deals with the estate and is named in the will to take care of the estate. An executor is often also a beneficiary within the will as they are usually a close family member or friend that the person who passed away trusted. The executor deals with distributing assets to people listed in the will and also wrapping up any affairs of the deceased.
If there isn’t a will in place, the administrator of the estate will have to arrange payment of the Inheritance Tax. The administrator carries out largely the same tasks as the executor would.
How do I pay Inheritance Tax?
The Inheritance Tax bill can be intimidating and you might wonder how you’re going to afford to pay it. Thankfully, Inheritance Tax is paid using funds from the estate or the sale of any other assets you inherit.
Sometimes, the person who’s passed away might have left money aside to pay for the Inheritance Tax. This is normally organised through a whole-of-life insurance policy.
When do you have to pay Inheritance Tax?
Inheritance Tax should be paid within six months after the death of the person leaving the inheritance. If the tax hasn’t been paid within this timeframe, interest will start being added to the Inheritance Tax owed.
You can choose to pay Inheritance Tax in instalments but interest will be charged on the outstanding amount. If an asset is sold before the Inheritance Tax has been paid, it should be paid at that point.
Why do we have to pay Inheritance Tax?
The idea of Inheritance Tax is to avoid inherited wealth keeping children of the rich unfairly rich. Inheritance Tax redistributes income so it can go back to the government and be distributed to benefit the country.
However, some may argue that when the money was earned, tax was already paid on it, so it’s being taxed twice.
Either way, Inheritance Tax is a fact of UK life that can’t be avoided.
How much is Inheritance Tax?
How much Inheritance Tax you pay depends on the value of the estate. The higher the value of the assets (property, investments, vehicles etc.) the more Inheritance Tax you’ll pay.
You don’t have to pay Inheritance Tax if:
- The value of the estate is below £325,000.
- OR the deceased leaves everything over £325,000 to their spouse, civil partner, or a charity.
If neither of these apply, then you’ll be taxed at 40% on anything above the threshold of £325,000. However, this threshold can be even higher in some circumstances which we’ll explain below:
What if I inherit my parent’s home?
If you leave your home to your children or grandchildren then you’ll have two tax-free allowances:
- £325,000 - standard Inheritance Tax allowance.
- £175,000 - 'main residence' band. Additional allowance you receive if you pass on a main residence to children or grandchildren.
This means that you might not have to pay Inheritance Tax on the first £500,000.
So, for example, if you leave a £550,000 home to your children, they won’t have to pay Inheritance Tax on the first £500,000. So, they’ll only pay 40% tax on the remaining £50,000.
How to avoid Inheritance Tax
There are a few different ways you can avoid Inheritance Tax or at least reduce the amount paid with some of our handy tips below:
1. Give gifts while you’re alive
You can reduce the Inheritance Tax bill by giving gifts whilst you’re still alive. If you’re considering making any large gifts, it might be worth seeking professional advice before doing so.
Here are some gift allowances to be aware of:
- Annual gift exemption - you can give £3,000 worth of gifts away each tax year without them being added to the value of your estate. So, these gifts won’t accrue Inheritance Tax. If you didn’t use last year's exemption, it carries over to the next year, giving you a maximum of £6,000. Note, this is your total personal allowance. You cannot give £3,000 to each person. If you have three children, you would only be able to give £1,000 to each child.
- Living for seven or more years - If you live for 7 or more years after your gift, no matter the size, no inheritance tax will be accrued. This is called a ‘potentially exempt transfer’. However, if you die before seven years, there is a tapered inheritance tax to pay:
|Years between gift and death||Tax due|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
- Wedding gifts - wedding gifts aren’t subject to Inheritance Tax if you stick within the allowances - £5,000 for your child, £2,500 for your grandchildren and £1,000 for anyone else.
- Small gifts exemption - you can also give unlimited gifts up to the value of £250 per person each tax year. This only applies if you haven’t used up another allowance with the same person.
So, if the value of your estate exceeds £325,000 you might want to consider gifting money before you die to avoid or reduce Inheritance Tax.
2. Gift money to charity in your will
Anything you leave to charity is exempt from Inheritance Tax. For example, Your estate might be worth £350,000. If you leave £30,000 to charity, you’ll then be exempt from Inheritance Tax. The £30,000 to charity is tax-free which leaves your total estate as £320,000, below the £325,000 Inheritance Tax threshold.
Choose a charity that means a lot to you and your family will be able to enjoy the inheritance without having to pay any tax.
3. Put some of your assets into a trust
If you place some assets within a trust then they won’t form part of your estate and so Inheritance Tax won’t be charged on them in event of your death.
A trust is a legal arrangement where you give money, property or other assets to a third party so they can look after them for the beneficiary.
For example, you could put some of your money in a trust for your children to access when they reach a certain age.
Once you’ve put something in a trust, it technically no longer belongs to you. This means that when you die, the value of what’s in the trust won’t be added to your estate and so won’t be charged Inheritance Tax.
When you set up a trust you can decide the rules as to how it’s managed. For example, your children can’t access the money until they are 21.
4. Leave everything to your partner
If you’re married or in a civil partnership with someone who lives in the UK, then you can leave them your entire estate and it’ll be exempt from Inheritance Tax, regardless of the size of your estate.
Also, married couples can pass their unused tax allowance to their partner when they pass away.
For example, a husband might leave his estate to his wife when he passes away. This means that he didn’t use any of his £325,000 Inheritance Tax allowance. So, when his wife passes away, her Inheritance Tax allowance will double to £650,000.
So, she could leave her children the estate and they won’t have to pay Inheritance Tax on anything under £650,000.