For anyone dealing with it for the first time, managing a death can feel like negotiating a maze of legal complexities. At Life Ledger, we understand the benefit a little guidance can deliver.
In this article, we’ve tried to break down the rules surrounding Inheritance Tax into some simple, easy to follow guidance. With this information at your disposal, we hope you can approach the Inheritance Tax process with confidence.
Where to start?
The legalities surrounding death are, by and large, completely unique. As a result, the majority of people won’t come across them, until they decide to write a will or are dealing with a death.
Then, they’ll have to quickly learn it all, right from the beginning.
Inheritance Tax is one of the most complicated areas of death management, and it often causes the public a lot of confusion.
How much Inheritance Tax will I have to pay? What assets are taxable? Is there a way that I can reduce my Inheritance Tax?
What is Inheritance Tax?
Once someone passes away, Inheritance Tax is a tax value that is taken from their estate, before it is distributed according to the will.
The Inheritance Tax value is calculated depending on the value of the estate. When valuing an estate for the purpose of Inheritance Tax calculations, you will need to include the deceased’s property, all of their money, any investments that they have made, life insurance payouts, and any possessions of value (such as vehicles or expensive jewellery).
However, it is important to note that not all estates will need to pay Inheritance Tax. In fact, according to HMRC, just 5% of UK estates have to pay Inheritance Tax.
What is the purpose of Inheritance Tax?
Inheritance Tax is, unsurprisingly, one of the most controversial types of tax out there.
Many see Inheritance Tax as taking wealth, which has been fairly earned by the deceased, away from those who stand to inherit. This money has already been taxed once, so it seems wrong to tax it all over again.
What’s more, if the deceased’s estate is particularly valuable, then the cost of Inheritance Tax can reach a huge amount of money.
However, in principle, Inheritance Tax is a legal requirement, because it redistributes wealth into the economy so that it can be invested by the state. Although the debate on its ‘fairness’ will continue, Inheritance Tax is not set to go away any time soon.
How is Inheritance Tax paid?
If the deceased left a will, then the executor of the will is normally in charge of managing the Inheritance Tax payment.
If the deceased did not leave a will, managing this payment will be one of the role requirements of the administrator of the estate.
The money can be gathered either by selling some of the deceased’s assets, or by using the money that the deceased has within their accounts. The deceased may have also set aside money (either in their will or through their life insurance policy), to be used to make the Inheritance Tax payment.
Either way, the payment is made via the government’s Direct Payment Scheme.The deadline for the payment is the last day of the sixth month after the deceased’s date of death. If you miss this deadline, then HMRC will add interest to the sum.
You don’t have to pay the entire Inheritance Tax sum by that deadline. In fact, the payments can be spread out in instalments, over a period of several years. However, note that interest will still be charged on the tax value that is still outstanding.
What are the thresholds for UK Inheritance Tax?
Inheritance Tax is calculated based on the value of the estate.
The calculation follows these rules:
If your total estate is valued at over £325,000, then the amount that exceeds this value will be taxed at 40%.
However, if you leave a minimum of 10% of this value to a charity (after deductions), then the tax rate will reduce to 36%.
These are the standard rules, but they differ in specific circumstances.
The big exemption is if you are married or in a civil partnership, and you leave your assets to your spouse in your will. If you do this and they live in the UK, then any assets left in this way when you die are tax-exempt.
Furthermore, under other circumstances, the tax-free threshold of £325,000 can be increased. If you leave your home to children, grandchildren, adopted children, foster children or stepchildren, then this threshold can be increased.
Another way that the tax-free threshold can be increased is by passing on any unused threshold to a surviving partner, providing that they are married or in a civil partnership.
For instance, if you leave your assets to your husband in your will, then your £325,000 allowance will be unused. So, this allowance will also be passed onto your husband, in the event of your death. This means that, when they pass away, they will have a £650,000 tax threshold (£325,000 multiplied by two) for their assets. This is referred to as a transferable nil rate band (TNRB).
In what circumstances would I not have to pay any Inheritance Tax?
You are not required to pay Inheritance Tax on your estate if either:
- Your estate is valued at less than £325,000.
- All of your assets (or everything above the £325,000 value) are left to your partner by marriage or civil partnership.
- You leave all of your assets above the threshold value to a beneficiary that is tax-exempt. These include charities or community amateur sports clubs.
Is it legal to try and reduce the amount of Inheritance Tax you pay?
Short answer – yes! It is completely legal to pre-plan ways that you can minimise the amount of Inheritance Tax that you are legally obligated to pay.
In fact, by investing some time in research, you can potentially save some pretty hefty sums. The effort is certainly worth investing. After all, it’ll be your loved ones that have to pay for the tax, out of their own inheritance.
You can reduce your Inheritance Tax in a number of ways:
- Giving money as gifts, a minimum of seven years before your death.
- Giving monetary gifts of £3,000 max, per year to a friend or family member.
- Giving monetary gifts of £250 max, per person, per year (this is NOT counted as part of the £3,000 mentioned above. But, it cannot be given to someone who has already received a £3,000 gift from you).
- Giving gifts of money, which has come directly from your income. Gifts of money that have come from your pension or earnings are Income Tax-exempt, as they do not count as part of your assets.
- Making a donation to a charity.
- Making a donation to a political party.
- Giving money or presents as wedding gifts, as these are tax-exempt. But, the limit to this is a £5,000 gift if you are their parent, £2,500 if you are their grandparent, and £1,000 if you are connected to the couple in another way.
Once it’s broken down into its constituent rules, Inheritance Tax immediately feels a whole lot more manageable.
And remember, if you have any further questions about any of the above, there are plenty of brilliant online resources out there to help:
- The UK website
- Age UK
- Martin Lewis’ Money Saving Expert website and forum