Many people worry about having to pay inheritance tax, but in reality only a few people have to pay it.
Inheritance tax (IHT) is a tax on the whole estate of someone who has died, which includes their property, possessions and money. If the estate is valued at less than £325,000 no tax is payable. This is called the Nil Rate Band (NRB).
If everything above this Band is left to a spouse or civil partner, or left to an exempt organisation such as a charity, no tax is paid on this portion. Otherwise it could be liable to 40% tax.
So, if your estate is worth £525,000 and your IHT threshold is £325,000, the tax charged will be on £200,000 (£525,000 – £325,000). The tax would be £80,000 (40% of £200,000).
The NRB is fixed at £325,000 until 2021, but your NRB might be increased if you’re widowed or a surviving civil partner. Couples can transfer any unused NRB when the first person died to the survivor.
This can double the amount of NRB available up to £650.000. This extra transferable element is known as Transferable Nil Rate Band (TNRB).
Recently the Residence Nil Rate Band (RNRB), or home allowance, has been introduced, which is on top of the NRB and the TNRB. To qualify for this you must pass your home or a share of it to your children or grandchildren. This includes step-children, adopted children, and foster children, but not nieces, nephews or siblings.
The table below shows the increases of the RNRB and the potential combined allowance:
|Tax Year||Resident Nil Rate Band (£)||Nil rate band (£)||Combined allowances|
After 2020/2021 the RNRB will rise with the Consumer Price Index.
If the value of the estate is £2 million or more the home allowance is reduced accordingly.
Provided certain conditions are met, the home allowance gives you an additional allowance to be used to reduce any IHT liability against your home.
You may also be able to use any unused RNRB from your spouse or civil partner’s estate if you’re widowed or a surviving civil partner. This can double the amount of RNRB available.
Valuing The Estate
So how is the estate valued? You will need to list all the assets and work out the value at the time of death, plus deduct any debts and liabilities. Basically, assets include items such as money in a bank, property and land, jewellery, cars, shares, a pay-out from an insurance policy and jointly owned assets. Also included are any gifts given away in the seven years before the person’s death.
Debts and liabilities include household bills, mortgages, credit card debts, and, in general, funeral expenses, but not any costs incurred after death, such as solicitor’s and probate fees.
Who Pays Inheritance Tax?
If there is a will, it’s usually the executor of the will who arranges to pay the Inheritance Tax (IHT). If there is no will, the administrator of the estate does this.
IHT can be paid from funds within the estate, or from money raised from the sale of the assets.
However, in practice, most IHT is paid through the Direct Payment Scheme (DPS). This means, if the person who died had money in a bank or building society account, the person dealing with the estate can ask for all or some of the IHT due to be paid directly from the account through the DPS.
Inheritance tax must be paid by the end of the sixth month after the person’s death. However, assets such as property can be paid in instalments over ten years. The outstanding amount of tax will attract interest, so it is a good idea to pay as much as possible in the first six months.
Reducing the Amount of IHT Paid
This is complicated, but essentially the amount paid can be reduced by:
- Leaving a legacy to charity
- Putting your assets into a trust for your heirs
- Leaving your estate to your spouse or civil partner
- Paying into a pension instead of a savings account
- Regularly giving away up to £3,000 a year in gifts.
In addition, taking out a life insurance policy to pay some or all of an Inheritance Tax bill can make things easier for your family when it comes to sorting out your estate after your death.
It can help protect your home and other assets from having to be sold to pay an IHT bill, which must usually be paid before probate is granted. This gives you the peace of mind you’re not leaving your family and friends a hefty tax bill to pay when you pass away.
Other Taxes to be Paid
The estate is only distributed after debts and Inheritance Tax are paid. Depending on what they inherit, your heirs might also incur:
- Income Tax – if what they inherit produces a regular income (e.g. share dividends or rent from a property).
- Capital Gains Tax – if they sell their inheritance (e.g. property) for more money than what it was worth when you died. How much they have to pay depends on whether they pay Income Tax at the basic or higher rate.
If your assets have been placed into a trust or you’re thinking about doing this, how much tax and what kind of tax they have to pay can get very complicated.
Take Expert Advice
This article provides a very good outline of how Inheritance tax works, it isn’t intended to be advice nor should you reply on it in relation to your specific circumstances. Taxes and rules change frequently, so everything here is correct at date of publishing. We would encourage you to seek expert advice to consider your specific personal circumstances. At Vincent & Co we advise you to speak to us sooner rather than later to discuss your estate and the impact of IHT on your family. Call us on 01803 500 500 for a confidential meeting.