A Complete Guide to Inheritance Tax
While we endeavour to provide you with as much information around Inheritance Tax as possible, it is important to note that your situation is unique to you. Inheritance Tax is complicated and this article should be seen as a guide only and not taken as advice.
YOUR estate, YOUR relatives/friends and YOUR afterlife wishes. Don't subject your estate to a 40% tax, yes, 40% tax if it can be avoided. Speak with an Inheritance Tax Professional TODAY!
We generally tend to assume that all of our estate will be passed on to our dependants automatically when we pass away, but that’s not always the case. A large proportion of the assets that you leave to your loved ones may, unfortunately, be subject to inheritance tax, also known as death tax.
IHT tax is currently set at 40%, it is not something to take lightly.
In this guide, we will touch on what the 2020 UK threshold for inheritance tax is, how to potentially increase your threshold, how to calculate your inheritance tax, how you can avoid paying it legally, and other discussion points about the dreaded IHT!
What does inheritance tax mean?
Life insurance and IHT rules in the UK
What is inheritance tax?
Inheritance Tax (IHT) is a tax owed to the government upon death, which is placed on your estate upon death (including all assets such as property, money, possessions, etc). At 40% of the estate's value, it can be quite a sizable sum. There are various allowances and thresholds which make it a lot more bearable, and seeking the advice of a professional to take advantage of these is a must.
The inheritance tax threshold for 2020 is currently set at £325,000, and will remain so until a revision in 2021. If the estate is worth £325,000 or below, it will not be subject to any inheritance tax.
What is included in an estate when someone dies?
An estate is the total amount of assets a person has upon their death – it can include:
- All current cash and savings
- Any company stock
- The value of any owned property
- The value of all other assets (for example, cars, jewellery, art, collections)
- Life insurance pay-outs not in trust
Then deduct any debts or liabilities which must be paid:
- Credit card debt
- Other debt
- Funeral expenses
Not quite as simple as it sounds, but the seven-year rule is designed for an estate to be passed onto relatives while you are still alive. If you survive 7 years after the gift has been made then no IHT will be levied against it.
However, the opposite is also true.
If you fail to plan ahead for the avoidance of IHT and begin gifting your estate at the last minute, anything that has been given away within the 7 years prior to your death will be held as part of your estate and potentially subject to the 40% IHT. Don't take that chance and start planning today!
Thankfully, with the correct advice, there are ways to avoid inheritance tax in the UK.
How to calculate inheritance tax
In general, but not always the case, if the estate is valued at £325,000 or less, your beneficiaries do not have to pay death tax. If the estate is passed on to a spouse or civil partner, there is no need to pay inheritance tax, and the same goes if the estate is passed on to a charity or other exempt beneficiary.
What percentage is inheritance tax in the UK?
Inheritance tax is charged at 40% once the thresholds have been reached and accounted for. So, any of your estate over the £325,000 threshold will be charged 40% inheritance tax.
Examples (correct as of 2020):
An estate worth £500,000 passed to a spread of family members will have a taxable amount of £175,000 (£500,000 minus the nil rate band of £325,000). Your estate will, therefore, be taxed 40% of £175,000, which is £70,000.
Another example, but this time utilising IHT advice:
An estate worth £1,000,000 including the family home worth £500,000 (this home is passed to the grandchildren of the deceased) will have a total taxable amount of £500,000.
Calculated as, £1,000,000 minus the £375,000 threshold + £175,000 allowance as the home was gifted to grandchildren*, gives a total allowance of £500,000.
The estate will therefore be deducted 40% of £500,000, which totals £200,000.
You will note that in both circumstances, IHT is not cheap! It can drastically affect the size of your estate that you have worked hard to build and pass on.
Who pays the inheritance tax to HMRC?
Your estate pays the IHT and the executor of the will is in charge of arranging to pay the IHT. In situations where there is no will, the administrator of the estate will do this. Contrary to popular belief, the beneficiaries (the people who inherit your assets) normally do not have to deal with tax issues.
When do you pay inheritance tax?
Normally, IHT should be paid within the first six months after the death. If the tax is not paid after this time, HMRC will begin to add interest to the remaining total.
It is possible to arrange an instalment plan with HMRC (for example, to avoid selling the home immediately to pay for taxes), but be aware that this will incur interest.
Sometimes it can take a long period to properly calculate the value of the estate. If this is the case and it is expected that IHT will be due, it is a good idea to have the executor pay off some of the tax before the six-month period to avoid interest. Money paid out of other accounts not held as part of the estate can be reclaimed from the estate once the value is fully calculated.
HMRC will always refund any overpayments.
Distributing inheritance to beneficiaries
The executor of the will does not usually distribute the remains of the estate to the beneficiaries until IHT has been paid in-full or any arrangement for a longer-term payment plan has been put in place.
Life insurance and inheritance tax
Life insurance policies can play a big part in IHT, as they can be set up to make a one-off payment, placed in trust, which covers the costs of inheritance tax.
It is important that any life insurance policies designed with this in mind are placed in trust rather than being paid directly into the estate, otherwise they become part of the taxable estate value themselves!
Using life insurance to pay IHT is an advised strategy for anyone who expects to leave a sizable estate for their family.
Read more: Putting Life Insurance in Trust
What other taxes do you have to pay on inheritance?
If anything inherited provides a regular income (for example, rent from a property) then it will be subject to income tax in the future.
Selling anything on and making a profit in the process could incur either income tax or, if the profit is substantial, capital gains tax.
For more advice on inheritance tax, or for a more in-depth look at some of the other options available with life insurance policies to cover IHT for your family, take a look at our library of articles here at CUKQ.
You might also like:
- 8 Tips to Legally Avoid Inheritance Tax
- Putting Life Insurance in Trust
- 5 Tips for Wills, Life Insurance and Inheritance Tax
- What is Probate?
*As an additional threshold, the RNRB is an extra amount (set at £175,000 in 2020 to 2021) which is added on to the NRB if the home, or a share of it, is passed on to children or grandchildren (which includes step-children, adopted children and foster children).