Figures released by HMRC show a £1billion increase in inheritance tax collections in 2022. Now standing at a record £7.1billion, the tax is no longer seen as something that applies to the wealthiest in society. In fact, almost a quarter more people are now said to be paying inheritance tax than were in the last financial year.
Increasing house prices have led to more families exceeding the inheritance tax threshold. This means inheritance tax planning is something everyone should consider and factor into their financial affairs. It is important to understand how it can affect loved ones and to explore strategies aimed at reducing inheritance tax liability.
Our FAQs provide a starting point with information to help you take important steps in reducing the amount of inheritance tax you may have to pay from your estate.
What is inheritance tax?
Inheritance tax is a tax on a person’s belongings when they pass away. It falls to be paid to HMRC out of the estate funds. The personal representatives are responsible for ensuring any inheritance tax liability is settled with HMRC.
Does inheritance tax apply to everyone?
No. Whether inheritance tax is payable depends on the value of the person’s estate and how their estate is disposed of. Tax may apply if a person’s estate is valued at more than £325,000. This is the minimum tax-free allowance that every individual is entitled to and is currently frozen until April 2028.
When is inheritance tax not payable?
An estate valued at less than the inheritance threshold of £325,000 won’t attract tax. If an estate is valued above the threshold, no tax is typically owed if everything exceeding £325,000 goes to the deceased’s spouse, civil partner, charity, or community amateur sports club.
How much is inheritance tax?
The amount of inheritance payable will depend on the size of a person’s estate and what allowances they have available. The standard rate of inheritance tax is 40%. This percentage is only applied to the value of the estate that exceeds the tax-free allowance that is available. If an estate is valued at £450,000 and only has the basic tax-free allowance, it would be subject to a 40% charge on the amount exceeding £325,000, i.e. £125,000 would be subject to 40% tax. The 40% rate can be reduced to 36% if the Will leaves 10% or more of the net estate to charity.
What does the nil-rate band mean?
The nil rate band is a tax-free allowance that every individual is entitled to and is currently set at £325,000. As well as the nil rate band, a person’s estate may be able to claim the residence nil rate band. The residence nil rate band is an additional threshold which is available where the deceased’s home is passing to a direct descendant. The residence nil rate band is currently set at £175,000. If the deceased’s estate is valued at £2 million or over the threshold is tapered down so the relief may only be available in part. See below for how much the threshold is tapered down by.
Does the £325,000 threshold apply to all estates?
Yes, and because of the availability of the additional residence nil-rate band, the overall allowance can rise to £500,000 where a deceased person leaves their home to a direct descendent and the estate is worth less than £2 million. For estates worth more than £2 million, the residence nil-rate band is reduced by £1 for every £2 over that £2 million mark.
Is it a case of ‘use it or lose it’ with the nil-rate bands?
No, unused elements of a nil-rate band and residence nil rate band can transfer to the deceased person’s spouse or civil partner. The new cumulative amount will further reduce the overall inheritance tax liability. This means that if a person dies leaving their entire estate to their spouse, the spouse could end up with a tax-free allowance of £1 million. It is also worth noting that a widow who has remarried may be able to use three nil rate bands in their inheritance tax planning.
What items are considered assets?
An asset refers to all the belongings owned by the deceased. Some of these will be obvious, such as their home, their money, investments, jewellery, car. Other assets may be less obvious, such as life insurance, money owed to the deceased, property held in trust, certain gifts given, and jointly owned possessions. It can be challenging to compile a comprehensive list of a person’s assets after they have passed away, as they may not have kept a detailed inventory, so this process can take time. While the value of most assets are taken into account for inheritance tax purposes, there are some exceptions to this. Certain life insurance policies and pensions are set up to fall out of a person’s estate for the purposes of inheritance tax.
How do you value an estate?
Valuing an estate can be a complex and time-consuming process that involves identifying, listing, and appraising various assets. Seeking expert help is often necessary, especially for evaluating valuable antiques and properties. In situations involving trusts and investments, professionals with expertise in law and finance are typically consulted for their specialised knowledge. Valuing an estate involves considering not only the assets but also the debts and liabilities associated with it. Any debts will be settled from the estate.
Valuing an estate accurately is essential in order to avoid overpaying inheritance tax. It is also important when disposing of assets during the estate administration period. Undervaluing an asset and subsequently selling it could trigger Capital Gains Tax. Determining the value of liabilities and debts at the date of death is particularly important for taxable estates. These values can be deducted from the gross value of the estate, reducing the overall value for inheritance tax purposes. Any debts that arise after the date of death, except for funeral costs which are deemed a pre-death expense for inheritance tax purposes, cannot be deducted from the gross value of the estate for inheritance purposes. However, they still need to be noted as a liability repayable from the estate.
What is the ‘seven-year rule’?
According to this rule, if a person gifts an asset to someone else and survives for at least seven years after making the gift, it will generally be exempt from inheritance tax upon their death. However, if a person passes away within seven years of making the gift, it may still be subject to inheritance tax. For example, you gift your daughter £20,000 or forgive the loan you provided for her house deposit; for a period of seven years, that amount is still considered part of your estate for inheritance tax purposes. If you pass away within those seven years, it will count for inheritance tax purposes. Tapering relief may be available if the value falling back to the estate exceeds the tax-free allowances available to the estate. However, if you live beyond those seven years, the gift is no longer counted for inheritance tax purposes. There are some exceptions to this rule, with the most prominent being gifts between married couples or between civil partners in the UK, which are exempt from inheritance tax. Additionally, there are specific allowances that can apply and mean certain types of gifts will not attract tax. These considerations are crucial in your financial planning.
If an estate is liable to inheritance tax when does it need to be paid?
Inheritance tax is due by the end of the sixth month after the person’s death. i.e. if a person passes away on 12 January 2023 the tax would be due by the end of July 2023. Any inheritance tax must be paid in full before Grant of Representation can be issued by the Court. The exception to this is where the assets qualify for the instalment option. If the inheritance tax is not paid in time, HMRC will charge a penalty for late filing.
How do I pay the inheritance tax if I do not have access to funds?
Most banks and financial institutions will release funds to pay inheritance tax. A form is sent to the bank making the request and funds are released directly to HMRC. Where there is a property that is yet to sell, you can apply to pay the inheritance tax in instalments which will bring the initial amount of tax due down. The instalment option will only apply to the value attributable to the property and daily interest will be applied until the full value of tax is settled. If there are insufficient or no funds available to settle the first instalment of inheritance tax, you may be able to get HMRC to agree for the Court to issue the Grant on loan pending the property being sold.