Inheritance Tax is a tax on the estate (the property, money and possessions) of someone who’s died.
How much is Inheritance Tax?
There is normally no tax to be paid if:
· The value of your estate is below the Nil-Rate Band of £325,000, or
· You leave everything above the Nil-Rate Band to your spouse or civil partner, or
· You leave everything above the threshold to an exempt beneficiary, such as a charity
If the value of your estate is above the Nil-Rate Band, then the part of your estate above the threshold might be liable for tax at the rate of 40%.
So, if your estate is worth£525,000 and your Nil-Rate Band is £325,000, then Inheritance Tax will be charged on £200,000 (£525,000 less £325,000). The Inheritance Tax liability would be £80,000 (40% of £200,000), assuming that you did not qualify for any other reliefs or exemptions.
The Nil-Rate Band is currently fixed at £325,000, but your Nil-Rate Band might be increased if you’re widowed or a surviving Civil Partner. Couples can transfer any unused Nil-Rate Band to their survivor. This can double the amount of Nil-Rate Band available up to £650,000.
The Residence Nil-Rate Band
The Residence Nil-Rate Band is on top of the Nil-Rate Band. To be eligible, you must pass your home to your direct descendants, such as: children and grandchildren, and also includes step-children, adopted children and foster children.
The current Residence Nil-Rate Band is £175,000 and like the main Nil-Rate Band, any unused Residence Nil-Rate Band can be transferred to your surviving spouse and civil partner.
There is a tapered withdrawal of the Residence Nil-Rate Band if the overall value of your estate exceeds £2 million. The rate at which the Residence Nil-Rate Band is withdrawn is £1 for every £2 that the value of the estate exceeds £2 million.
Provided certain conditions are met, the Residence Nil-Rate Band gives you an additional allowance to be used to reduce any Inheritance Tax liability against your home.
How to value the estate
To value an estate, you will need to:
· List out all of the assets and work out their value at the date of death
· Deduct any debts and liabilities
You should keep records of how you worked out the values, such as estate agent’s valuation for the home.
Assets can include items such as money in a bank account, property and land, jewellery, cars, cars, shares, a pay-out from an insurance policy and jointly owned assets.
Gifts also need to be included, such as cash or other assets, if they were given away in the seven years before the person died. You will also need to include any gifts given before this period if the person who died continued to benefit from the gift. These are known as ‘gifts with reservation of benefit’, for example, if they gave away their house but continued to live in it.
Debts and liabilities reduce the value of the deceased’s estate chargeable to Inheritance Tax. This includes mortgages, debts and in general, funeral expenses. However, any costs incurred after death, such as solicitor’s and probate fees, cannot be deducted from the estate’s value for Inheritance Tax purposes.
Please see our Inheritance Tax Calculator for a guide to your Inheritance Tax position. Although, please note that our calculator is just a guide and you should seek advice to obtain an accurate calculation for your individual circumstances.
Who pays Inheritance Tax?
If there is a will, it is usually the executor of the will who arranges to pay the Inheritance Tax. If there is not a will, it is the administrator of the estate who pays the tax.
Inheritance Tax can be paid from funds within the estate, or from money raised from the sale of the assets. However, in practice, most Inheritance Tax is paid through the Direct Payment Scheme (DPS). This means that if the person who died had the money in a bank account, the person dealing with the estate can ask for all or some of the Inheritance Tax due to be paid directly from the bank account.
Sometimes the person who died may have left money to pay the Inheritance Tax. Normally, this is through a whole-of-life insurance policy, which remains in force until the policyholder’s death, as long as the premiums are paid. Payments from a life insurance policy could be subject to Inheritance Tax. But, by writing the policy in trust, the tax should be avoided. This way you also avoid going through the often-lengthy probate process.
Once the tax and debts are paid, the executor or administrator can distribute what remains of the estate.
Inheritance Tax gifts, reliefs and exemptions
Some gifts and property are exempt from Inheritance Tax, such as some wedding gifts and charitable donations. Relief might also be available on certain types of property, such as farms and business assets.
If the person who died gave a gift in the seven years before they died, it is counted as part of the estate, and likely to incur Inheritance Tax.
How much tax is due depends on the value of the gift, when it was given and to whom.
How can I reduce the amount of tax paid?
Trying to reduce how much Inheritance Tax is due on an estate is complicated. But, in short, you can reduce how much tax is paid by:
· Leaving a legacy to charity
· Putting your assets into a trust for your heirs
· Leaving your estate to your spouse or civil partner
· Paying into a pension instead of a savings account, as pensions are not deemed to be part of your estate for Inheritance Tax
· Regularly giving away up to £3,000 a year in gifts