Inheritance tax (IHT) is one of the four primary taxes in the UK, alongside income tax, national insurance (NI), and capital gains tax (CGT).
IHT is the tax imposed on the estate of someone who has passed away, including all their assets such as property, money, and possessions. Understanding how IHT works and what it involves is essential for effective estate planning.
Here, we explore the fundamentals of IHT to help you navigate its complexities and make informed decisions for the future.
What is the inheritance tax rate?
At the time of writing, the UK has a nil rate band for IHT, meaning the first £325,000 of an estate’s value is exempt from tax. Any value above this threshold is taxed at 40%.
However, if the deceased leaves at least 10% of their net estate to a registered charity, the inheritance tax rate can be reduced to 36%.
This tax rate structure makes estate planning a valuable step to manage taxes efficiently, allowing individuals to plan for charitable giving if it aligns with their wishes.
When wouldn’t there be IHT to pay?
Inheritance tax does not apply in certain situations, such as:
- When the deceased’s estate is left entirely to a surviving spouse or civil partner.
- When the estate is left to a registered charity, which is fully exempt from IHT.
These exemptions allow individuals to plan their estates in a way that supports their beneficiaries or causes that matter to them.
How is IHT impacted when the estate is left to a direct descendant?
For estates that are passed to direct descendants, such as children and grandchildren (including step, foster, and adopted), there’s an additional exemption called the residence nil rate band (RNRB).
This exemption means there will be no IHT on the first £175,000 of the main residence’s value if left to a direct descendant.
When combined with the standard nil rate band of £325,000, the total IHT-free allowance can reach £500,000.
Moreover, if a spouse or civil partner passed away without using their tax-free allowance, it can be transferred to the surviving partner. This means that for a couple, the estate passed to children can have up to £1 million exempt from IHT.
Note: if the deceased estate is worth more than £2 million, then the RNRB will gradually reduce by £1 for every £2 that the estate is over £2 million.
IHT reliefs and exemptions
Inheritance tax reliefs and exemptions can significantly reduce the tax burden on your estate, particularly when planning ahead with gifts or passing on qualifying assets such as business interests.
Gifts
Gifting during one’s lifetime is a popular way to reduce the value of an estate and, consequently, the IHT liability. Under the seven-year rule, gifts are tax-free if the giver survives for at least seven years.
If the individual passes within this period, the gift may still be taxed, though taper relief can reduce the amount payable depending on the time elapsed since the gift was made.
Additional gifting allowances include:
- Annual exemption: Gifts of up to £3,000 per tax year are exempt.
- Small gifts: You can give up to £250 per person per tax year, provided no other allowance is used for the same individual.
- Wedding gifts: Exempt up to £5,000 for a child, £2,500 for a grandchild, and £1,000 for any other person.
- Normal expenditure out of income: Regular gifts made from surplus income can be exempt, provided they don’t affect your standard of living.
These allowances make gifting an effective tool in estate planning when done with foresight.
How are business assets treated?
Business relief allows certain business assets to be passed on either free of IHT or with a reduced tax bill, depending on the nature of the asset and the time it has been owned.
This relief aims to support family businesses, ensuring they can remain operational across generations without being burdened by IHT.
Chargeable lifetime transfer (CLT)
A CLT applies to certain gifts made during a person’s life that are immediately subject to IHT. If the value of the gift is within the nil rate band of £325,000, no IHT is due right away.
However, any value over the nil rate band is taxed at 20%. CLTs often include gifts made into discretionary trusts, a popular vehicle for those looking to transfer wealth while still maintaining a level of control over distribution.
How is inheritance tax paid?
IHT is typically managed by the executor of the estate (if there is a will) or by an administrator (if there isn’t a will).
They are responsible for paying IHT to HM Revenue and Customs (HMRC) before distributing the assets to the beneficiaries.
Executors must understand these responsibilities, as IHT must be paid by the end of the sixth month after the person’s death.
How can we help?
At Rosart, we understand that estate planning and managing inheritance tax can feel overwhelming, but we’re here to help guide you through the process.
Our goal is to help you protect your wealth and pass it on according to your wishes, all while minimising tax implications. Reach out to us for tailored IHT planning and to ensure that your money goes further.