Inheritance Tax: Everything You Need to Know

“In this world, nothing can be said to be certain, except death and taxes.”

— Benjamin Franklin

When looking into estate planning, you may have encountered Inheritance Tax. But how much do you actually know about it? In this blog, we’ll cover everything you need to know about Inheritance Tax and ways to potentially minimise it and pass more of your assets onto your loved ones.

What Is Inheritance Tax?

Inheritance Tax (often abbreviated to IHT) is the tax levied on the entire estate of someone who has recently passed away, including property and money. It applies to all of your estate above the nil rate band, which is currently set at £325,000 and is charged at a rate of 40%. For example, on an estate worth £500,000:

  • Estate value – £500,000
  • Nil Rate Band – £325,000
  • Amount Taxable @ 40% – £175,000
  • IHT Amount Payable – £70,000

However, since 2017, people have been able to pass on up to £500,000 IHT free with the residence nil rate band. If you leave property to a family member, you can pass on an additional £175,000 without paying any tax, but this is only applicable if you leave property to a child or grandchild. 

IHT is not the only tax your loved ones may have to pay on the gifts you leave to them. If their inheritance includes something that produces a regular income, such as dividends or rent from a property, they will also have to pay income tax. They may also have to pay Capital Gains Tax if they sell their inheritance for more than what it was worth originally. 

Tax must be paid on your estate by the end of the sixth month after you pass away, or HMRC will begin charging interest. Your executors will be responsible for managing IHT and distributing gifts to your beneficiaries, so be mindful of who you pick!

Spouses and IHT

Married couples and civil partners can often pass their assets onto each other tax-free. In cases where one partner transferred their assets to the other upon their death, the remaining partner can then use both tax-free allowances as long as the deceased spouse did not use their total IHT allowance. You can pass on up to £1m tax-free if your estate includes your home. 

Gifts and Inheritance Tax

There are several ways to lower IHT to pass on more of your assets to your loved ones, such as using gifts. You have a gift allowance that you can use every year to potentially lower the value of your estate before you pass away and, therefore, potentially lower IHT. You can give away up to £3000 every year IHT-free, as it will not be considered part of your estate when you pass away. This gift allowance also stacks up, so if you do not use it for one year, you can give away £6000 after two years. However, it does not stack anymore after two years, so be sure to utilise it properly!

Leaving gifts to charity in your Will can also reduce your overall IHT bill. If you leave over 10% of your total estate to a charity in your Will, your IHT rate is then reduced by 10%. Wedding gifts are also tax-free up to a limit. You can give £5000 to your child, £2,500 to your grandchild, or £1000 to anyone else without it counting towards your annual gift allowance. 

Small gifts of £250 per person also don’t count towards the annual £3000 gift limit. You can give as many people as you like gifts of £250 tax-free, but you can’t combine gifts for the same person, so if you have already gifted someone £3000 from your tax-free gift allowance, you can’t gift this additional £250. 

Other gifts you make throughout your lifetime can be classified as potentially exempt transfers (PETs) and may be IHT-free. If you survive for seven years after making the gift, no tax will be payable, but if you pass away within this time, it will still be classed as part of your estate. However, even if you pass away before the seven years is up, the gift may be eligible for taper relief, where the IHT rate is reduced depending on how long it has been since it was made:

  • 0-3 years – full IHT payable on the gift. 
  • 3-4 years – IHT payable at 32%.
  • 4-5 years – IHT payable at 24%.
  • 5-6 years – IHT payable at 16%.
  • 6-7 years – IHT payable at 8%. 

Lowering IHT

Aside from gifts, there are several other ways to reduce your IHT bill, such as:

  • Putting assets into a trust – when you place your assets into a trust and certain conditions are met, they no longer belong to you. Therefore, they will not be counted when working out the IHT bill. Your chosen beneficiaries will still benefit from the trust, giving you an extra level of control over the assets. 
  • Using life insurance – you can take out a life insurance policy to pay your IHT bill to make things easier for your loved ones and help protect your assets from being sold to pay taxes. Life insurance policies may be counted as part of your estate unless you specify that it is held in trust, which can often be done at no extra cost. 
  • Leaving your estate to your partner – leaving your entire estate to your partner can exempt you from paying any inheritance tax. 

IHT could apply to your estate after you pass away, but if you want to leave more to your heirs, there are ways to lower the amount payable. Get in touch with The Planning Bee today and discover how to maximise everything you leave behind for your family with tax planning and trusts.

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