Inheritance Tax (IHT) is a tax imposed on a deceased person’s estate, including all of their property, assets, and money. Even if you don’t have any Inheritance Tax to pay, you must still notify HMRC. IHT is a section of the UK tax system, which is exceedingly extensive, complex, and intricate. There are different exemptions and laws concerning gifts that, with the correct knowledge and assistance, can help you lower the size of your estate and minimise your tax burden.
What is Inheritance Tax?
IHT is a tax that may be imposed if you intend to leave assets to your heirs after you die. Your estate is made up of your property, goods, and money, and it may be gifted to your spouse or civil partner tax-free. Depending on your circumstances, you may be able to pass on some, most, or all of your assets tax-free to other family members or people.
IHT in the UK?
IHT is calculated at 40% of the value of your estate. However, a £325,000 tax-free allowance is known as the nil-rate band (NRB). The value of an individual’s estate beyond the nil rate band is subject to IHT at 40% unless it is handed directly to a spouse or registered civil partner when they die. The worth of your estate includes everything you possess, including your home.
The value of your estate for inheritance tax includes:
- your savings
- possessions including property
- money for pensions (certain payments from payment funds may be subject to Inheritance Tax)
- the value of any money or property you gave away in the seven years leading up to death, subject to certain exceptions
Regardless of who you leave it to, the nil-rate band ensures that no tax is levied on the first £325,000 of your estate. When a married couple or registered civil partners dies, the unused portion of their IHT-free allowance can be transferred to their living spouse. There are also a number of different techniques that may be used, depending on your specific financial status, to either reduce the amount of your estate or boost your NRB, thereby lowering your tax liability. These are discussed in greater depth later in this article.
What’s exempt from Inheritance Tax?
The amount you pay is determined by the value of the deceased’s estate, which is calculated by their assets (cash in the bank, investments, property or company, cars, life insurance payouts), less any debts.
- There will be no Inheritance Tax if you leave your whole estate to your spouse, wife, or civil partner.
- Any unused portion of a husband, wife, or civil partner’s £325,000 tax-free threshold can be handed to their surviving partner.
- Anything you give to charity is exempt from Inheritance Tax. If you leave 10% or more of your estate to charity, the remainder of your estate may be taxed at a reduced rate of 36 per cent. However, there are certain restrictions, so get legal counsel if you want to do so.
- Inheritance Tax exemptions apply to gifts of up to £3,000 each tax year, as well as small gifts to individuals and some wedding or civil partnership gifts. However, depending on how much you gave and when you gave it, gifts made while you were alive may be subject to Inheritance Tax.
- If you give away your home to your children or grandchildren, your threshold can increase to £500,000.
How to calculate the size of your estate?
On estates valued more than £325,000, IHT is usually applied. Of course, there are exceptions to this rule. You must value your estate in order to determine whether the profits of your will would be subject to IHT. You can list everything you possess, including your assets, and calculate their value:
- Savings (including ISAs)
- Debtors (money you’re owed)
Pension funds and life insurance policies, for example, are often excluded from your estate. After establishing your total value, you’ll need to tally up all of your debts and liabilities. This is most likely to include:
- Borrowing on a mortgage
- Loans for individuals
- Debt on a credit card
- Tax liabilities
- Bills that have not been paid
- Expenses for the funeral
Then you deduct all you owe from everything you own to get at your estate’s net current worth. You’ll be able to see if your estate is worth more than the NRB of £325,000 or £500,000 if you own your property.
The NRB for couples can be as high as £650,000, or even £1 million in the case of property ownership, depending on your financial circumstances. The value of your estate is likely to rise over time, and you should be aware that this might result in increased tax liability.
Transfer of nil rate band or IHT Allowance
Every person has their own NRB. Even if some or all of the NRB remains unused when the individual dies, it is often impossible to transfer the NRB to someone else. There is an exemption in married couples and members of a civil partnership, which allows the first spouse’s or civil partner’s unused portion of the NRB to be passed to the survivor. This implies that any part of the NRB that isn’t utilised when the first spouse or civil partner dies can be transferred to the surviving spouse or civil partner for use after the first spouse or civil partner’s death.
The special rules for married couples or those in civil partnerships are:
- When you die, assets left to your spouse or registered civil partner are excluded from inheritance tax if they live in the UK.
- Furthermore, your partner’s inheritance tax allowance is increased by the amount of your allowance you did not spend, allowing a couple to leave £1 million tax-free (2 x £325,000 tax-free allowance + 2 x £175,000 main residence allowance).
Family Home Inheritance TaxHH
In the tax year 2021/22, there is no inheritance tax on the first £325,000 of an estate, with a 40% rate applied to anything beyond that. However, you will be taxed less if you leave your house to your direct descendants, such as children or grandchildren.
If you’re passing your family home to a lineal descendant or a spouse/civil partner of a lineal descendant, it’s considered slightly differently for IHT purposes. Direct descendants do not include nieces, nephews, or friends. This implies that you must leave your home to your children, grandchildren, or their spouse/civil partner.
You’ll be assigned a primary residence band phased between 2017 and 2020. This might increase your NRB by £175,000 to £500,000, as long as your family home generates at least £175,000 of the value of your estate.
Only one house may qualify for the primary residence nil-rate band or RNRB, and it must be included in your estate. A trust cannot be used to hold your house. To qualify it as your home, you must also have lived in it at some point throughout your life, but not necessarily at the time of your death. If you own more than one house that qualifies for the RNRB, your estate executor can choose which one to utilise.
Couples who own their own house essentially obtain a combined allowance, allowing the RNRB to grow to £1 million, where £350,000 of that value comes from their home.
- The £175,000 main residence allowance only applies if your estate is worth less than £2 million.
- On estates worth £2 million or more, the main residence allowance will decrease by £1 for every £2 above £2 million that the deceased’s estate is worth.
Techniques to cut your IHT tax bill
Some gifts are free from IHT regardless of whether they are given during your lifetime or after your death, while others are exempt only if given during your lifetime. If a gift is exempt from IHT, it will not be considered to determine whether IHT is due.
Unless you live for another seven years or more after making the gift, the money given away before you die is usually regarded as part of your estate. If you give away more than £325,000 in the seven years before your death, those you give gifts to will be charged inheritance tax (on a sliding scale up to a maximum of 40%) – therefore, it’s critical to prepare ahead of time how to pass on your assets.
Other methods to save money on your tax bill
There are several other tax exemptions to consider in order to reduce your tax bill:
Gifts to your spouse or civil partner
If you give a gift to your spouse or civil partner during your lifetime or after your death, it is free from IHT if they are UK-domiciled or deemed domiciled. If you have any doubts about your domicile status, we highly advise you to seek expert guidance. These lifetime transfers to individuals are called Potentially Exempt Transfers (PETs).
If you live for seven years from the day you made the gift, it will be entirely free of IHT. If you pass away within seven years, the gift may be subject to IHT. However, you will have to pay IHT only if the amount of your taxable estate on death, together with the value of PETs made during the past seven years, exceeds the nil rate band at the time of death.
When you make a PET, you do not need to tell HMRC, and there will be no tax to pay at the time of the gift. You should keep track of all the PETs you create throughout time, in date order, until the seventh anniversary of each gift, when you should remove them from your list.
Values up to the current nil rate band limit (currently £325,000) may be transferred to a non-domiciled spouse or civil partner as of April 6, 2013. If the transfer is made on death, any additional cash transferred is subject to IHT. PETs are lifelong transfers to a non-domiciled spouse or civil partner. Gifts to unmarried partners or partners with whom you are not in a registered civil partnership are not covered by this exemption for gifts to spouses or civil partners.
Gifts to charities
Most UK charities and registered community amateur sports clubs are eligible for IHT exempt gifts, which can be made during your lifetime or after your death. This exemption also applies to qualified charities based in the European Union and a few other countries.
Gifts to political parties
You can give an IHT-free gift to any UK political party if at least two MPs in the House of Commons or one MP and received at least 150,000 votes in the last general election.
Inheritance tax-free yearly gifts
You may give significant gifts up to £3,000 per tax year, and if you don’t spend it, you can carry it over to the next tax year. You can also make as many smaller gifts as you choose, up to £250 each. These are referred to as “lifetime gifts.”
You may give gifts for a number of occasions. Some options include:
- The expense of your grandchildren’s schooling
- Junior ISAs for children
- Deposits throughout a lifetime ISA to assist the family with a first-time buyer’s deposit
- Wedding Costs
- Contribute to the funding of further education.
If your children get married, you can give them presents without paying inheritance tax on them. However, there are certain limitations: A present from a parent is worth £5,000, a gift from a grandparent is worth £2,500, and a gift from anybody else is worth £1,000. This gift must be given on or shortly before the wedding or civil partnership ceremony.
It’s worth noting that while IHT may not be due on some lifetime gifts but some may result in a chargeable gain, resulting in a capital gains tax bill. This is why you should get tax guidance that considers all of your affairs not to receive any unexpected tax bills.
IHT and your pension
Private pensions can be a valuable tool for avoiding IHT. This is because any unused pension funds can be passed on to your heirs. This isn’t the case with defined-benefit pensions, however. There is no tax to pay if you die before reaching the age of 75. If you die beyond that age, your beneficiaries will have to pay income tax on the money you leave them.
Pension savings are often excluded from estate planning and, as a result, from IHT. This is why pensions should be considered when saving for later life. It would help if you kept in mind the annual pension limit of £40,000 per year, as well as the lifetime allowance, which is now £1,073,100.
What pushing up the IHT receipts
You may not have to pay taxes right away when you inherit anything, but you may have to pay taxes later. This is because you may be required to pay income tax on earnings earned by the asset you inherit, as well as capital gains tax if you later sell the item. Consider the revenue from dividends on stocks or the rental income from inherited property.
If IHT is due on gifts you got before the person who gave them to you dies away, you will almost likely have to pay the tax. The charge will be transferred to your estate if you cannot pay the debt. Any income tax or capital gains tax due to assets you inherit must be reported on your tax return.
Due to the number of unexpected fatalities, the Office for Budget Responsibility anticipated that the COVID-19 pandemic would result in a 20% rise in the number of households with IHT obligations. If they come as a shock, they’re less likely to be factored into the estate and tax planning. HMRC’s receipts from inheritance tax (IHT) between April and July 2021 jumped to GBP2.1 billion, a third higher than in the same period in 2020. The extra GBP0.5 billion received in the period is believed to be due to higher volumes of wealth transfers during the COVID-19 pandemic. Receipts in the 2020/21 tax year were 4 per cent higher than the previous tax year.
As a consequence of the freeze, the Treasury expects to raise an additional £1 billion in IHT over the following five years. This emphasises the importance of following the guidelines in this article and seeking expert assistance so that planning may be tailored to your specific situations to ensure that your liability to IHT is as minimal as feasible.
With this in mind, make sure you grasp the current rules and budget for your retirement and inheritance in accordance with them. Because tax treatment is dependent on your particular circumstances, you should get professional advice from a certified tax adviser before acting on this information. Any tax exemptions or thresholds listed are subject to change based on specific circumstances and current legislation. Please do not hesitate to contact Bloom Financials’ highly skilled tax consultants for more assistance and guidance.