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Inheritance Tax: A Guide

Mike Hunt

The last thing we want to consider when a loved one passes away is their estate's tax implications. The inheritance tax system in the UK is sadly a reality, and in what follows, we will look at the consequences of the regime and what it means to you and your loved ones.

What is Inheritance Tax, and how much does it cost?

A straightforward way to describe Inheritance Tax (IHT) is that it is a tax on all property, possessions, and money left by a deceased person. When a loved one passes, how much will become liable?

In most cases, no tax is due if:

  • The estate is valued below the Nill Rate Band (NRB) of £325,000.
  • Your spouse or civil partner is responsible for everything outlined above or above the threshold.
  • An exempt beneficiary receives anything above the threshold, such as a charity.

It is estimated that only 4 to 5 per cent of UK households pay IHT. However, if the value of your estate is above the NRB, you might be required to pay 40% tax.

In the example below, if your IHT threshold is £325,000 and the estate is worth £525,000, the tax due will be on the £200,000 (525,000 - £325,000) threshold. That means you will have to pay £80,000 (40%) of that amount. NRBs are fixed at £325,000 until 2021, but the Government may raise them if you are widowed, or a civil partner survives you. When a couple's first partner dies, any unused NRB can be transferred to the surviving partner.

Adding the extra transferable element is called the Transferable Nil Rate Band (TNRB), which can also double the available NRB up to £650.000.

A home allowance has recently been introduced as the Residence Nil Rate Band (RNRB). The RNRB sits above the NRB and the TNRB. To qualify, you must leave your home to your children or grandchildren. This includes stepchildren, adopted children, and foster children but does not include nieces, nephews, or siblings.

The following is a table showing the RNRB increases and the potential combined allowance:

2018/19 Resident Nil Rate Band (£)125,000 Nil rate band (£)325,000 Combined allowances (£)450,000

2019/20 Resident Nil Rate Band (£)150,000 Nil rate band (£)325,000 Combined allowances (£)475,000

2020/21 Resident Nil Rate Band (£)175,000 Nil rate band (£)325,000 Combined allowances (£)500,000

The RNIB will increase in line with the Consumer Price Index (CPI) after 2020/21. When the overall value of your estate exceeds £2 million, there is a tapered withdrawal of the home allowance. You can use the allowance to reduce your IHT liability against your home, provided you meet certain conditions.

In addition, you may have access to any unused RNRBs from your spouse's or civil partner's estate if you're a widower or surviving civil partner. RNRB can be doubled as a result. On Gov.UK, you can find out more about transferring unused Inheritance Tax thresholds. On Gov.UK you can also learn more about the Residence Nil Rate Band and how to transfer unused RNRB.

Inheritance tax: who pays it?

The executor of the will is usually the one to pay the Inheritance Tax (IHT). In the absence of a will, the administrator of the estate is responsible for this. The executor can pay IHT from assets in the estate or from money raised from the sale of assets, but this is not always the case.

Direct Payment Scheme (DPS) is the most common way in which IHT is paid. A person handling the estate can ask the DPS to pay the estate's IHT directly from an account held by the person who died. This is if the person had money in a bank account or a building society account.

IHT is sometimes due from the estate of the deceased. Whole-of-life policies remain in force until the policyholder dies as long as they pay the premiums. Payments received from the policy could be subject to IHT. You can avoid the tax by putting the policy in trust. You also avoid navigating through the lengthy probate process this way.

Following the payment of taxes and debts, the executor or administrator can distribute the remainder of the estate.

Calculating Your Estate's Value

You will need to do the following to work out the basis of your estate:

  • Please make a list of all the assets and value them at the date of death.
  • Subtract any debts and liabilities.

Always keep records of how you calculated it, such as an estate agent's valuation. Documents can be requested by HMRC up to twenty years after Inheritance Tax (IHT) has been paid, so keep them handy.

Items such as money in a bank, properties and land, jewellery, cars, shares, a payment from an insurance policy, and jointly owned assets are considered assets.

It is also necessary to include gifts such as cash or other assets that the deceased gave away during the seven years before the person died and any gifts given before this period if the person continued to benefit from the gift. These are also called 'gifts with reservations of benefit'. These are gifts made with the intent of continuing to enjoy the benefits.

Also, it is vital to remember that the value of the deceased's chargeable estate reduces if they have debts or liabilities, such as household bills, mortgages, credit card debt, and, generally, funeral expenses. HOWEVER, for IHT purposes, any costs incurred after death, such as solicitor's and probate fees, cannot be deducted from the estate value.

When is inheritance tax due?

You will need an IHT reference number three weeks before you make a payment if you need to pay Inheritance Tax (IHT). This can be done either by mail or online.

Additionally, inheritance tax (IHT) must be paid by the end of the sixth month following the individual's death. Taxes that are not settled within this timeframe will be subject to interest charges by HMRC. There is the option for executors to pay the tax on certain assets, such as property, over ten years by instalments. However, interest will still be charged on the outstanding amount.

Even if your executor hasn't yet priced the estate, it's a good idea to pay some of the tax within six months of death if IHT is likely to occur. To reduce the amount of interest that the estate may be charged if the debts and taxes are not paid off promptly, the estate will sell the assets as soon as possible. Executors and administrators can claim back taxes from the estate on their accounts if they are remitting them from the estate.

When someone dies, their property, money, and possessions become subject to probate. When probate is granted, HMRC will also refund any overpaid IHT to the estate. It is called confirmation in Scotland.

To avoid a penalty, you will need to send in an estate account within a year of being appointed executor or administrator.

What can I do to reduce the overall amount of IHT?

A reduction in IHT on an estate is incredibly complex and requires expert advice, but you can reduce the amount you pay by:

  • Charitable legacies
  • in the wills of spouses or civil partners
  • Leaving assets to your heirs in trust
  • Regularly giving loved ones gifts worth up to £3,000 a year
  • By investing in a pension

Gifts and exemptions from Inheritance Tax

Inheritance Tax (IHT) does not apply to some gifts and property, such as wedding gifts or donations to charities. Farms and business assets may also qualify for relief.

If the deceased gave a gift in the seven years leading up to their death, it would be included in their estate and would incur IHT.

The amount of tax due on a gift depends on the value, when it was given, and to whom it was given.

Life insurance can pay inheritance tax 

By paying at least part of or all of your Inheritance Tax bill with a life insurance policy, you can make things easier for your family when it comes to settling your estate after your death.

The executor must generally pay the IHT bill before probate can be granted, so protecting your home and other assets may prevent your home from being sold for IHT. You'll have peace of mind knowing IHT will not burden your family and friends after your death.

Probate usually is granted before IHT is paid. When it comes to property, however, HMRC may accept staged payments until the property is sold - a bank might also release money if it is paid directly to HMRC to pay an IHT bill.

Unless your policy is written 'in trust', most life insurance policies will count as part of your estate. Your beneficiaries will receive the money, not your legal estate. You will not be taxed on any payouts that don't count toward your threshold. Your heirs will receive their money much more quickly by avoiding a lengthy probate process.

Often, a whole-of-life insurance policy is used for this purpose, which remains in force as long as the policyholder pays the premiums. To help you make the right decisions for your situation, it is well worth getting advice to help you with estate and tax planning.

If you plan to use life insurance to pay IHT, you have two options:

  • Whole Life Insurance Policy
  • Term Insurance Policy

There is an additional risk that your loved ones would face a large tax bill if you were to pass away within seven years. This is because you gifted assets to them. The recipient of the gift is often responsible for paying this bill rather than the estate.

Are my Heirs responsible for any other taxes on their inheritance?

Inheritance tax (IHT) and debts (if any) are paid before your estate is distributed.

Your heirs may also face these expenses, based on what they inherit:

  • If the inheritance produces a regular income (such as dividends from shares or rent from a property), the heir must pay income tax.
  • Tax on capital gains - if your inheritance (e.g. property) is sold for more than its original value when you die. 
  • Whether they have to pay income tax at the basic or higher rate determines how much they pay.

We would always recommend that you speak to a financial advisor, tax adviser or solicitor to help work this out.

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