What is Inheritance Tax?

Inheritance tax is also known as IHT and is charged on the estate of an individual who has died.

The most common parts of an estate to be eligible for IHT include property, possessions and money.

HMRC gives individuals an IHT tax free threshold which means estates with a value of less than £325,000 do not qualify.

For those with estates worth more than the IHT threshold it’s worth considering tax planning to minimise the tax paid on death.

There are options available to reduce a future inheritance tax bill but they require careful consideration and need to be operated quickly enough to ensure your loved ones receive the maximum inheritance possible.

What are the IHT Rates?

The standard rate for inheritance tax is set at 40%. IHT is only applicable on parts of an estate above the IHT tax free threshold.

A reduced IHT rate of 36% may be available in circumstances where you leave 10% or more of your net estate to charity.

What is the IHT Nil Rate Band?

The IHT nil rate band is given to all individuals and is set at £325,000. Anything up £325,000 is tax free after which IHT will become applicable.

In the event that the threshold has not been fully utilised when the initial partner in a marriage or civil partnership passes away, the remaining portion can be transferred to the surviving partner.

If the first partner in a married or civil partnership dies and their £325,000 threshold was not fully used, the surviving partner can benefit from an increased basic threshold of up to £650,000 for tax free allowance.

The amount of unused threshold from the deceased partner’s estate is added to the surviving partner’s estate’s basic threshold.

To transfer the threshold, a request must be sent to HMRC within two years of the surviving partner’s death.

Inheritance Tax Residence Nil Rate Band

The IHT residence nil rate band is established at £175,000 per individual and could potentially be accessible upon the demise of an individual if the value of their estate exceeds the standard nil rate band threshold.

In the event that you meet the criteria for the IHT residence nil rate band, it will be granted in addition to the existing £325,000 allowance for inheritance tax.

By combining both the nil rate band and the residence nil rate band, you can ensure that the first £500,000 of your estate (£325,000 + £175,000) is exempt from inheritance tax.

Can Inheritance Tax be lowered?

Some people may believe that IHT is inevitable and don’t explore the options available to them.

However, for those who wish to minimize the tax paid upon their death inheritance tax planning is crucial.

Some of the common ways to lower inheritance tax include:

  • Leaving your estate to your spouse or civil partner.
  • Using the annual gift allowance by giving away gifts.
  • Handover your assets to a trust which will give access and ownership of those assets to a designated person(s) after you die.
  • Pay into a pension scheme that can be transferred to chosen person after your death.

Who has to pay IHT?

Inheritance tax can be payable by the executor is there is a will or if there is no will the administrator of the estate.

Payment for IHT can be made from the estate’s funds or through the sale of assets. In reality most IHT payments are made via the Direct Payment Scheme (DPS).

IHT Estate executor

When someone passes away, the executor of their estate is responsible for using the funds to pay Inheritance Tax to HM Revenue and Customs (HMRC). An executor is typically appointed as part of a an individuals will (executor of the will).

In cases where a will is not in place the administrator of the estate normally arranges for the payment of IHT to HMRC.

IHT Beneficiaries

The beneficiaries who inherit the estate typically do not have to pay taxes on their inheritance.

It is possible that they may have to pay income tax on assets left to them in the will for example rental income from a property.

IHT Gifts

If you give gifts exceeding £325,000 to someone and they pass away within 7 years some IHT may be applicable to the recipient.

IHT and Gifts

If you give gifts within seven years before you pass away there is a possibility that inheritance tax will have to be paid on them.

An annual IHT exemption is given to all individuals on gifts with a value of £3000 or less.

The IHT annual exemption allowance can be split between multiple people and can be carried forward by one tax year only if unused.

For inheritance tax to be due will mainly depend on:

  • the recipient’s relationship with you.
  • the gift’s value.
  • the date it was given.

Your estate constitutes all of your assets and it’s value will determine if inheritance tax is required to be paid on any gifts.

Typically the estate pays the Inheritance Tax on gifts but if the value of the gifts given by you exceeds the £325,000 limit the recipients of those gifts will have to bear the inheritance tax on the gifts they receive from you during that period.

What is classed as a Gift for IHT purposes?

Understanding what can be classed as a gift for IHT purposes and keeping appropriate records is important.

Anything that is mentioned in the will is not considered as a gift but is considered as part of the estate including all money property and possessions left after death.

The most common items and assets classed as gifts include:

  • Personal possessions for example jewellery.
  • Unlisted shares held for less than two years before death.
  • Shares listed on the London stock exchange.
  • Money lost when selling something for less than its worth. For example when a house is sold to a child below its market value the difference in value will be counted as a gift.

In order to manage your estate the individual in charge will have to record the gifts you provided during the 7 years preceding your passing.

For this reason it’s recommended that you maintain a record of the following information: the recipients and contents of the gifts, the gift’s value as well as the date on which it was given.

What is Taper Relief for IHT?

Taper relief applies only if the total value of gifts made in the seven years before death exceeds the tax free threshold of £325,000.

When giving gifts, if you live for seven years after giving them there will be no tax due except if the gift is part of a trust.

However if you die within seven years of giving a gift and there is Inheritance Tax to pay taper relief is used to tax gifts on a sliding scale.

The amount of IHT depends on the date the gift was given with gifts given within three years before death taxed at 40%, while gifts given between 3 to 7 years before death are taxed on a sliding scale known as ‘taper relief’.

Taper Relief Rates:

Years between gift and death

3 to 4 years: 32% rate of tax on the gift

4 to 5 years: 24% rate of tax on the gift

5 to 6 years: 16% rate of tax on the gift

6 to 7 years: 8% rate of tax on the gift

7 or more: 0% rate of tax on the gift

What is the Residence Nil Rate Band?

The government has introduced an additional nil rate band known as the ‘residence nil-rate band’ on top of the tax free threshold of £325,000.

The current residence nil rate band has been set at £175,000 and only applies to the main residence you lived in before passing, which was given away before your death.

If you add the residence nil rate band to the IHT free threshold you receive a total tax free allowance of £500,000.

Essentially if you decide to leave your previous home to any of your children including foster, adopted, or step children, or grandchildren then they will not have to pay IHT on its initial £500,000 value (£325,000 for the nil-rate band and £175,000 for the residence nil rate band) if they decide to sell it.

If you are a married couple or in a civil partnership you can combine your nil rate bands allowing for the first £1,000,000 of your assets including your property to be exempt from IHT.

Trusts and Inheritance Tax

A trust is a method of handling assets, such as money, investments, land or buildings on behalf of individuals. There are several types of trusts and each has a distinct tax implication.

Trusts typically involve three parties – the settlor who contributes assets to the trust, the trustee who oversees the trust and the beneficiary who receives the benefits from the trust.

If you transfer your assets to a trust while meeting the necessary conditions you no longer have ownership of them.

The trust takes possession of the cash, investments, or property which means their value usually won’t be included in your inheritance tax calculation after your death.

Business relief for Inheritance Tax

Business Relief is a mechanism that reduces the value of a business or its assets for calculating Inheritance Tax.

For inheritance tax purposes any ownership or share of a business is included in the estate.

Estate’s business assets can be eligible for business relief of either 50% or 100%, which can be passed on while the owner is still alive or as part of the will.

When calculating relief at 50%, the market value of the business or asset must be used.

Business Relief can be claimed on property and buildings, unlisted shares and machinery.

The executor of the will or administrator of the estate can claim business relief when valuing the estate by filling in form IHT400 (Inheritance Tax account) and schedule IHT413 (Business or partnership interests and assets).

Should I use an IHT Adviser?

While some individuals may feel that their money is their own to spend others prioritise reducing their tax burden for the benefit of their heirs.

Inheritance tax planning will make use of all the available IHT allowances and reliefs to help reduce the tax bill on your estate.

An IHT adviser can highlight what you can give away tax free during your lifetime, keep compliant records and apply taper relief where applicable.

You can also be guided on areas like IHT business relief and the use of life insurance to pay for a future IHT bill.

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