Understanding Inheritance Tax

June, 2022

If the value of your assets reaches anything above £325,000 (or over £650,000 for a married couple or a couple in a civil partnership), your estate will owe inheritance tax at 40%. Thinking about the financial future of your loved ones isn’t just about writing a will. It’s about ensuring they don’t pay unnecessary taxes. 

Why do we have to pay inheritance tax?

Inheritance tax was created to redistribute some of the wealth of the rich. It goes to the state for the benefit of all, but it’s not hard to see why so many people think it’s unfair.

When the money was originally earned, tax would have been paid. With inheritance tax, it feels like you have to paid twice.

Who pays inheritance tax?

Inheritance tax applies to your estate. The estate must pay its tax bill before the assets can be passed on to beneficiaries. These are the people, as set out in the will, who are receiving money, possessions or property. But not that many people meet the threshold and pay inheritance tax.

It’s natural to want to reduce your family’s tax bill if you think your estate might be worth more than £325,000. We have put together a guide that will outline everything you need to know about inheritance tax, estate planning, and how much you can give away as gifts.

What should usually happen when someone passes away?

  1. Check if there's a will
  2. Apply to get a grant of representation
  3. Pay any inheritance tax that's due
  4. Collect the estate's assets
  5. Pay any debts
  6. Distribute the estate

Introduction to distributing wealth after death

No-one wants to think about their hard-earned wealth going to waste after they die. It’s up to you to decide who gets what. The people who could benefit from your estate include your partner or spouse, children and other family members, friends and charities. Family dynamics are complex, but they tend to be the main beneficiaries.

Sorting out your finances early can help the people left behind when you die. Remember to talk to the people your choices impact. After all, they’re the people who need to get clued up on the different taxes they might have to pay.

Valuing the estate of the deceased

When someone dies, you need to find the market value of their assets. In other words, a realistic selling price. You have to do this before you can get a grant of representation. This is also known as “grant of probate”, “letters of administration” or “letters of administration with a will”. It gives you the legal right to deal with their property, money and possessions as instructed in their will. You’ll need a grant unless the following applies:

  • The estate passes to the surviving spouse or civil partner because it was held in joint names.
  • The estate doesn’t include land, property or shares.

How much is inheritance tax?

An estate will owe tax at 40% on anything above the £325,000 inheritance tax threshold. This threshold doubles to £650,000 for married couples or couples in a civil partnership. So, if you leave behind assets worth £400,000, your estate won’t owe any inheritance tax on the first £325,000. It will owe 40% on the remaining £75,000 – making the total tax bill £30,000. If you had the same assets but were part of a married couple, you wouldn’t owe anything because you’ve got double the allowance.

The tax is lowered to 36% if you leave at least 10% to charity. But we’ve got more on reducing your tax bill later.

Who is responsible for paying?

The estate is responsible for paying inheritance tax to HM Revenue and Customs (HMRC). The person dealing with the estate – the executor – should organise this.

Ideally, they’ll use money from the estate but this isn’t always possible. Once the tax has been paid, they can distribute the assets as set out in the deceased’s will.

When and how to pay your inheritance tax bill

From the date of death, you have a year to fill in the inheritance tax forms. After six months, the estate will be charged interest. To avoid excessive charges, it’s worth paying all, or some, of the inheritance tax early on.

You can pay inheritance tax in full, or you can start making payments before you know the exact amount owed. These are known as payments on account. However you want to pay your inheritance tax bill, you need to follow these steps:

-       Get an inheritance tax reference number from HM Revenue and Customs – at least three weeks before you make a payment.

-       Make payments. You can pay from your own bank account and claim the money back from the estate at a later date with a grant of representation (known as probate, or confirmation in Scotland). You can also do this with a joint account you shared with the deceased. You can also pay from accounts owned by the deceased using the same methods, or use national savings and investments or government stock they owned.

How can I reduce inheritance tax?

Inheritance tax is a financial fact. That’s not to say you can’t minimise taxes, court costs, and unnecessary legal fees with effective estate planning. You’ve just got to understand what needs to be paid, when and how, as well as where you could make huge savings. 

Setting up a trust can reduce the amount of tax an estate must pay and increase the amount of money for families. For example, by setting up a trust for your children, inheritance tax will be charged at 20% for the amount that exceeds the normal threshold. However, if you die within seven years of setting up the trust, an additional 20% is charged – making it equal to the non-trust rate.

There are other ways of reducing your inheritance tax bill, including:

  • Giving money or property to a spouse
  • Making gifts to other family members
  • Giving money to charity

How much you can give away as a gift

If you’re married or in a civil partnership, you can give your possessions to your partner without worrying about the estate paying inheritance tax on what it’s worth. All transfers between such couples are tax-free. 

What you decide to give other family members and friends is up to you. But gifts can easily incur tax if you don’t plan well. The current rules allow you to pass on money, property or possessions without paying inheritance tax, as long as you survive for seven years after the gift has been given.

You can’t plan the time of your death. But, by understanding inheritance tax, people tend to decide to make generous gifts whilst they’re still healthy and feeling good. If something was to happen, the estate would owe some inheritance tax. The rates follow a taper system, as shown in the table below. For example, if you die within six years, the estate will pay 8% inheritance tax on any gift over the threshold. 

-       If your death is less than 3 years after the gift was made, the full 40% tax will be deducted.

-       If your death is 3-4 years after the gift was made, the full 32% tax will be deducted.

-       If your death is 4-5 years after the gift was made, the full 24% tax will be deducted.

-       If your death is 5-6 years after the gift was made, the full 16% tax will be deducted.

-       If your death is 6-7 years after the gift was made, the full 8% tax will be deducted.

-       If your death is more than 7 years after the gift was made, 0% tax will be deducted.

This is why is it so important to think about gifts to loved ones when you are fit and. Healthy so that they are left with less inheritance tax to pay.

Exemptions from inheritance tax

There are some exceptions that allow you to give more without paying tax.

  • You can give up to £250 a year to as many people as you like
  • Anyone can give away up to £3,000 tax-free a year. If you don’t use this annual exemption, it can be carried over for the following year but only up to a maximum of £6,000
  • Gifts made at the time of a wedding or civil partnership are given tax-free allowances:
    • £5,000 can be given to a child
    • £2,500 can be given to a grandchild or great grandchild
    • £1,000 can be given to anyone
  • If you can show the gift was funded out of surplus income, not savings, you won’t pay inheritance tax. But it’s a complicated matter to prove, and you need to make a written declaration confirming the gifts are paid for out of income, not from savings or investments

In addition to exemptions on gifts, not everyone will have to pay inheritance tax. You qualify for relief if the following applies:

  • If you’re in the armed forces, police, or are a firefighter, paramedic, or humanitarian aid worker, and die in active service, your estate doesn’t have to pay inheritance tax. This includes people injured during active service and whose death was hastened as a result.
  • Businesses can qualify for either 50% or 100% tax relief
  • You can pass on a farm without worrying about inheritance tax, but certain assets, including machinery, will still need to be valued to check if tax is owed on them.
  • The land of woodland properties isn’t subject to inheritance tax, although the trees will be if they’re sold or given away as timber.
  • Heritage assets, including buildings, land, or objects of national scientific, historic or artistic importance, could be exempt from inheritance tax. 

Qualifying for relief is a complicated process. It’s worth contacting the government's inhreitanct tax and probate enquiries office to get additional support.

Advice on inheritance tax and spouses

When you get married or enter a civil partnership, you share your assets but still get individual allowances for the inheritance tax threshold. As a couple, this means you can pass on assets worth £650,000 before inheritance tax will be owed. What’s more, this tax-free allowance can be passed on after the first death.

If your spouse dies, and you inherit all assets tax-free, the individual tax-free allowance won’t have been used. When you pass away, your estate will be able to use this doubled allowance. 

You’re allowed to do this with a portion of allowance – for example, if the assets passed on to other family members after the first death totalled £162,500, only 50% of the tax-free allowance has been used. At the time of your death, you’d be able to pass on assets worth £487,500 before any inheritance tax is due. This rule applies if your partner has already died, as long as they died after 12 November 1974.

To understand inheritance tax more, speak a financial advisor and make sure you have a will in place so you can be sure your loved ones will receive as much of your estate as they can.



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