It’s a good idea to know about inheritance tax if you’re making a will, or if you’re sorting out someone else’s will. In this article, we’ll look at the main points about inheritance tax to give you an overview.
What is inheritance tax (IHT)?
Inheritance tax, sometimes called IHT for short, is a type of tax on the estate of someone who’s died. The estate is the total value of the person’s money, property and possessions. The amount of tax that needs to be paid depends on the value of what’s been left and also who it’s left to (the beneficiaries).
How much is inheritance tax?
The standard inheritance tax rate is 40% of the part of the estate that’s above the threshold. The threshold is £325,000, so inheritance tax will be payable on 40% of any of the estate that’s over this threshold.
For example, if your estate is worth £350,000 then you’ll pay 40% tax on £25,000 as this is the amount that’s above the £325,000 threshold.
But it’s also worth knowing that in some cases you can leave more than £325,000 without having to pay inheritance tax. We’ll look at this in more detail in this article.
What if you’re married or in a civil partnership?
If you’re married or in a civil partnership, you might be able to leave more than £325,000 before inheritance tax has to be paid. You can find out more about inheritance tax for married couples and civil partners in this article by Which? here.
Do you pay less inheritance tax if you leave money to charity?
Yes. There’s a reduced rate of 36% on some of your assets if you leave 10% or more of the ‘net value’ to charity in your will. The ‘net value’ means the estate’s total value after any debts have been paid.
Are there any situations where you don’t have to pay inheritance tax?
Yes, there are. If one of these situations applies to you, you don’t usually have to pay inheritance tax:
- If the total value of the estate is below the £325,000 threshold (this is called the ‘nil rate band’)
- If you leave everything above the £325,000 threshold to your married partner or civil partner
- If you leave everything above the £325,000 threshold to a charity or a community amateur sports club (these are called ‘exempt beneficiaries’)
If you decide to leave your home to your children or grandchildren, your tax-free threshold can increase to £500,000. The law includes adopted, foster and stepchildren as your children.
Can you estimate inheritance tax in advance?
Yes. You might find it helpful to work out how much inheritance tax you would have to pay. That way you can think about any steps you need to take to make sure your family (or other beneficiaries) receive as much as of your estate as possible. You can find a handy inheritance tax calculator on the Which? website here.
Do you pay inheritance tax on a house?
This partly depends on whether you pass your home on before or after you die.
If you pass your house on before you die
You can legally give your home away before you die if you want to. If you pass it on and move out, you don’t usually have to pay inheritance tax if you live for another 7 years.
If you die within 7 years, a rule called the ‘7-year rule’ applies.
If you want to stay in your home after you’ve passed it on, you’ll need to:
- Pay rent to the new owner at the ‘going rate’ (a similar rent to other properties in the local area)
- Pay your share of the bills
- Live in the house for at least 7 more years
If you pass your house on and don’t do the above, the law treats it as a type of gift called a ‘gift with reservation.’ In other words, you’ve given the house away but continued to benefit from it afterwards.
This means the house will be added to the total value of your estate when you die. It might then mean inheritance tax has to be paid on the estate. This will depend on what the overall total value of it is.
If you pass your house on after you die
If you want to, you can leave your home to your husband, wife or civil partner when you die. There’s no inheritance tax to pay if you decide to do this.
If you want to leave your home to someone else in your will, it’ll count towards the value of your estate when you die. It might then mean inheritance tax has to be paid on the estate, depending on the overall total.
If you decide to leave your home to your children or grandchildren, your tax-free threshold can increase to £500,000. The law includes adopted, foster and stepchildren as your children.
Your estate has to be worth less than £2 million to benefit from the £500,000 threshold.
Does a spouse pay inheritance tax?
It’s usually the case that married couples and civil partners can pass on their assets and property tax-free. If you die before your spouse or civil partner, they’ll be able to use your unused tax-free allowance of £325,000 as well as theirs. This comes to a total allowance of £650,000.
Your spouse or civil partner can’t benefit from this extra tax-free allowance if you’ve given away a lot of money in your will.
There’s a technical term for the extra money your surviving spouse or civil partner is allowed tax-free if you die without using your allowance. This is known as the ‘transferable nil-rate band.’ You can read more about the rules on this on the Gov.UK website here.
Are pensions included in inheritance tax?
Usually, pensions can be passed out of the estate so they won’t be subject to inheritance tax. For this to happen, you’ll usually need your pension to be set up under a discretionary trust. This means that your pension provider has the right to decide who receives any money from your pension after you die.
While most pensions are set up in this way, not all are. So it’s best to speak to a financial adviser if you’d like help with your pension for inheritance tax reasons.
What’s the 7-year rule in inheritance tax?
If you die 7 years after giving someone a gift, there’s no inheritance tax to pay on it unless the gift is part of a trust.
If you give someone a gift less than 7 years before you die, they might have to pay inheritance tax on it. This will depend on:
- Who you gave the gift to and their relationship to you
- When you gave them the gift
- The value of the gift
Many different things can be classed as a gift when it comes to inheritance tax. Some examples might be a house, money, jewellery and stocks and shares.
It’s a good idea to get professional advice about what you can give as a gift tax-free. It’s also important because different rates apply depending on the value of the gift and when you die. You can speak to a solicitor or a tax adviser about this.
Who pays the inheritance tax to HMRC?
If you make a will, you’ll name a person to deal with your estate in it. This will be your ‘executor.’ Your executor is responsible for paying any inheritance tax from your estate. They’ll pay this to HM Revenue and Customs (‘HMRC’).
If you don’t make a will, the administrator of your estate pays the inheritance tax.
If someone else dies and you’re their executor, you can read more about reporting the value of the estate to HMRC for inheritance tax on the Gov.UK website here.
Where do the funds for inheritance tax come from?
Inheritance tax can be paid from funds within the estate, or from funds from the sale of the assets (for example by selling a house).
The most common way inheritance tax is paid is through the Direct Payment Scheme (‘DPS’). This means it can be paid in full or in part from the bank or building society account of the person who’s died. The executor or administrator can ask for this to happen.
When do you have to pay inheritance tax by?
Inheritance tax should be paid by the end of the six months after a person has died. HMRC will start charging interest if it’s not paid by then.
The rules on payment are different if you’re making payments on a trust.
Read more about how to pay an inheritance tax bill and the rules on this on the Gov.UK website here.
Do you pay inheritance tax on life insurance?
It’s usually the case that life insurance policies will count as part of the estate. This can be avoided if the policy is written ‘in trust’ when it’s taken out.
This means that when you die, the money from the policy goes to the people you’ve left it to in your will (the ‘beneficiaries’) and not the legal estate. The payout doesn’t count towards your inheritance tax threshold and won’t be subject to inheritance tax.
Are funeral costs exempt from inheritance tax?
Yes, as long as the costs are reasonable. There’re no set rules on what’s reasonable because it’s different in every case. This means it’s best to take a sensible approach or HMRC might ask for a breakdown of what’s been spent on funeral costs.
You can learn more about average UK funeral costs.
You can find our article on paying for funeral expenses from the estate here.
Inheritance tax can be a tricky topic to deal with, but it can be made more straightforward if you get the right advice from a specialist solicitor or financial adviser. If you make a will, it’ll also be much easier for your loved ones to sort out inheritance tax when you die.