Inheritance tax: a UK guide

The tax on a person’s estate after they’ve died is called inheritance tax (IHT). While it currently applies to less than 5%* of UK estates, this figure is expected to rise over the coming years. According to the Office for Budget Responsibility, IHT receipts will increase every year until 2027, when they are predicted to reach £7.6 billion – up from £5.1 billion in 2019/20. In this article, you’ll discover what inheritance tax is, who has to pay it, how it’s calculated and if there are ways you may be able to reduce the amount you’ll pay.

Inheritance taxInheritance taxInheritance tax

What is inheritance tax?

Inheritance tax** is the tax payable on the estate of someone who has passed away. Estates are made up of various assets, for example, money, property, pensions and possessions. How much tax you’ll need to pay will depend on the entire value of the estate.

Who has to pay inheritance tax?

If the deceased person has left a will, the executor of that will usually arrange payment of inheritance tax. However, if there isn’t a will, it typically falls to the administrator or person in charge of the estate to pay the inheritance tax. There are also ways to pay IHT before you’re legally required to do so. IHT can be paid from funds that come from within the estate or from money raised by selling assets or property. 

Most people pay inheritance tax through direct payment schemes. If the deceased had money in a bank account, the person dealing with taxes on the estate can ask for IHT to be paid directly from this account. Alternatively, the person who died may have already taken IHT into consideration. This is usually arranged through a whole-of-life insurance policy which remains active until the holder’s death as long as their premiums are paid.

When do you have to pay inheritance tax?

Inheritance tax should be paid by the end of the sixth month after the estate holder’s death. If you fail to pay within this timeframe, HMRC may start charging interest. You can also choose to pay tax on certain assets in installments over and up to 10 years. However, this will incur interest. 

In cases where the estate is sold before IHT is paid, the executor must ensure that IHT, including instalments and interest, is paid at the same time. If the executor or administrator pays the inheritance tax from their own account, they can claim this back from the estate.

How much is inheritance tax and how is it calculated?

The standard rate for inheritance tax is 40%. This only applies when the value of an estate exceeds the UK’s inheritance tax threshold of £325,000 (also known as the nil-rate band). This threshold has been frozen until 2025/26.

Normally, if the value of the estate is below the inheritance tax allowance of £325,000, then beneficiaries won’t have to pay inheritance tax. Any estate you inherit above this amount will be subject to a tax rate of 40%. For example, if you leave behind assets worth £400,000, your estate won’t pay tax on the first £325,000. It will have to pay 40% on the remaining £75,000. This means the inheritance tax will be £30,000. 

However, there is no IHT to pay if you pass your assets to your surviving spouse or civil partner, provided they’re living in the UK. You can also transfer any unused amount of your inheritance nil-rate band allowance to them.

If you’d like to calculate the inheritance tax you might need to pay, you’ll find an easy-to-use calculator on the government website.

Passing on a family home

In 2017, the government introduced a new allowance – the Residence nil-rate band (RNRB) – to help more people pass on a family home without paying IHT. The RNRB is set at £175,000 in 2021/22 and applies where a residence is passed, on death, to direct descendants such as a child or a grandchild. 

When added to the main nil-rate band of £325,000, the RNRB effectively increases an individual’s inheritance tax allowance to £500,000 (or £1 million for a couple). However, there is a tapered withdrawal of the RNRB for estates with a net value of more than £2 million.

Inheritance tax gifts, reliefs and exemptions

The annual exemption

You can give away a total £3,000 worth of gifts each tax year without them being included in the value of your estate. This is known as the annual exemption. Gifts or money up to this amount can be given to one person or split between several. If you don’t use the full allowance in one tax year, you can bring forward the remaining amount to the following tax year. However, you can only do this for one tax year.

Small gift allowance

Gifts of up to £250 made to any number of people are also exempt from inheritance tax. They don’t count towards the £3,000 annual exemption, although you can’t give £250 to someone on whom you have already used another allowance. 

Wedding gifts

You can give a tax-free gift to someone who is getting married or entering into a civil partnership, subject to certain limits. You can currently give up to £5,000 to a child, £2,500 to a grandchild or great-grandchild and £1,000 to any other individual in any one tax year. The wedding gift allowance can also be combined with another allowance, such as the £3,000 annual exemption. However, the small gift allowance is excluded.

The seven year rule

Any gifts given at least seven years before your death are exempt from IHT. However, gifts made within seven years of your death are added back into your estate for the purpose of inheritance tax.

The amount of IHT payable depends on when the gift was made. Gifts given in the three years prior to your death are taxed at the standard rate of 40%. Gifts given between three and seven years are reduced on a sliding scale in the form of taper relief (see below).

Number of years between gift and death Rate of IHT payable on gift
3 - 4 32%
4 - 5 24%
5 - 6 16%
6 - 7 8%

Other reliefs

Relief may also be available on certain types of properties such as farms, woodland or business assets, in which case you’ll need to file a self-assessment tax return.

Can I reduce the amount of inheritance tax I need to pay?

Reducing IHT can be complex, and it’s important to seek financial advice for your personal situation. There are a few ways you might be able to reduce the amount of inheritance you need to pay, including the following:

  • Leaving at least 10% to charity – The rate of inheritance tax is reduced to 36% if you leave 10% or more of your estate to charity
  • Putting your assets into a trust for intended heirs – When you put cash, investments or property into a trust, it effectively no longer belongs to you. Provided certain conditions are met, this may mean these assets fall outside the remit of inheritance tax. You should always speak to a solicitor or financial adviser for tailored advice
  • Choosing to leave your estates to your spouse or civil partner – There is no IHT to pay if your estate passes to your spouse or civil partner. They can also inherit your unused nil-rate band, effectively boosting their own inheritance tax allowance by a further £325,000
  • Paying into pensions instead of savings accounts – Pensions can be a very tax-efficient way of passing on money because, unlike savings, they aren’t included in your taxable estate
  • Make regular gifts – You can give away a total of £3,000 every tax year. You can also make unlimited small gifts of up to £250, while wedding gifts up to a certain limit are also exempt from IHT (see ‘inheritance gifts, exemptions and reliefs’ above).
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Using life insurance to pay an inheritance tax bill

If inheritance tax remains a concern, you might want to take out a life insurance policy. While this won’t reduce your IHT liability, it will help to cover some or all of the final bill. Not only will this give you peace of mind, but it can also make matters easier for your family and friends after your death.

*https://obr.uk/forecasts-in-depth/tax-by-tax-spend-by-spend/inheritance-tax/

**https://www.gov.uk/inheritance-tax

 

 

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