The world of Inheritance Tax (IHT) is a minefield. As many people are unaware of how they can minimise the amount of Inheritance Tax payable on their estate, their estate can incur heavy taxes upon their death.
The Planning Bee is here to help – keep reading for our complete guide to Inheritance Tax.
What is Inheritance Tax?
Often abbreviated to IHT, Inheritance Tax is the tax payable on the estate of someone who has died. The tax is applicable on all assets, including property, money, and possessions.
The amount of tax payable on estates varies. If the total value of your estate is below £325,000, your beneficiaries will pay no IHT on your estate. This is known as the nil-rate band, and around 95% of estates fall below this threshold. This threshold can increase to £500,000 if you give away your home to your children or grandchildren.
Couples can pass on unused allowances to one another. For example, if one spouse passes away and leaves their assets to the surviving spouse tax-free, the surviving spouse then has an IHT-free allowance of up to 650,000 (or up to £1m if leaving your home to direct descendants).
Everything above the threshold is taxable at a rate of 40%. However, there are many ways to help lower this tax and leave more of your estate to your loved ones.
Property is often the most significant asset that most people own. You can pass on your house to your spouse or civil partner without incurring any Inheritance Tax, but if you leave your home to others, it counts towards the value of your estate.
The residence rate nil band (RNRB) can help to decrease the amount of IHT payable on your estate. The RNRB amounts to £175,000 and can stack on top of the nil rate band of £325,000, making one person’s total IHT-free allowance a maximum of £500,000. However, this will only count if you leave your home to your children or grandchildren, including adopted and stepchildren.
The RNRB can also be transferred to the surviving partner if their spouse passes away before them. The surviving partner can leave up to £1m to their beneficiaries tax-free.
Some gifts and assets may be exempt from Inheritance Tax. Gifts left to charity are free from IHT, as are wedding gifts. Parents can give up to £5,000 as a wedding gift tax-free, and grandparents can give £2,500. Some people may give away gifts in the years before their death, though if they pass away before seven years have elapsed after the gift, it will be counted as part of their estate, and IHT will need to be paid on the gift.
However, the amount of IHT paid on these gifts lowers after time. For example, if a person passes away less than three years after a substantial gift is made, the amount of IHT paid on the gift will be the full rate of 40%. If they pass away over three years after making a gift, the IHT rate drops to 32% and decreases by 8% per year until incurring no IHT after seven years has passed.
Gifts between spouses and civil partners are tax-free, and each person gets a £3,000 gift allowance per year. This can roll over into the following year, so the maximum that can be given as a gift is £6,000. With small gifts up to £250, these gifts will not incur inheritance tax.
Reducing Inheritance Tax
There are several ways that you can reduce the amount of IHT payable on your estate, these include:
- Put your assets into Trust – establishing a Trust where you are not a beneficiary, takes assets out of your hands and means that anything held in Trust is likely to be exempt from IHT.
- Leave your estate to your spouse – there is no Inheritance Tax applicable if you leave all of your assets to your spouse.
- Give away up to £3,000 per year in gifts – this gift allowance is exempt from IHT and can reduce your estate to below the nil rate band.
- Leave a legacy to charity – leaving a gift to charity can reduce the IHT on your estate more than you may think. If 10% of the net estate is left to charity, the IHT rate on your estate drops to 36%.
- Gifting assets away – if you gift assets away and survive seven years, the gift is then outside of the estate from an IHT calculation. However, you cannot gift an asset away and still expect to benefit from it, e.g. the home you live in (you’d have to pay market rent to the recipient).
Who Pays Inheritance Tax?
The person named as executor in the Will arranges to pay IHT. The executor can then pay IHT from money within the estate or by selling off assets. Most Inheritance Tax is paid through the Direct Payment Scheme, which takes money from the bank or building society accounts of the deceased.
In some cases, IHT can be paid out of an insurance policy. However, payments from an insurance policy may also be susceptible to IHT, although this can be avoided by adding the policy to a Trust.
The estate executor must pay Inheritance Tax within six months of the person’s passing, and interest may be charged if it is not paid by the end of the six months. Even if the estate has not been completely evaluated by the end of the six months, the executor should make a payment on account, in which they pay some of the tax off. This can help to reduce the interest that unpaid IHT can incur.
Paying IHT can be complex, and it can be difficult for grieving families to go through settling their loved one’s estate, so you may consider employing a professional executor to help make this process run smoothly.
The world of Inheritance Tax can be confusing. There is a lot of information to keep straight, and it can be difficult to know how to use your allowances to reduce the amount of IHT that your estate has to pay.
The Planning Bee is here to help. Contact us today to find out more about establishing Trusts and crafting Wills that will help you maximise the amount that your beneficiaries will receive. Our expert paralegals are available for a free consultation about your later life planning.