Inheritance tax is important because it impacts the amount of money you can leave for your loved ones when you die, but how does it all work?
Inheritance tax is something many people, especially those with considerable assets, need to think about as they get older and thoughts naturally turn to what is going to happen when they pass away. It is a tax on the money or belongings we leave behind when we die, and can also apply to certain gifts we make during our lives. But what is it, and what do we need to know about it?
Inheritance tax explained
If a person's estate, which comprises their money, property and possessions, is worth more than £325,000 at the time of their death, then inheritance tax will have to be paid. This £325,000 figure, known as the inheritance tax threshold, has been at this level since 2010/11, and will remain there until at least 2020/21.
In addition to the standard nil rate band, the Budget in July 2015 introduced the Main Residence Nil Rate Band (MRNRB). This is an additional allowance that can be used to offset up to £175,000 per person of the value in their main residence. Therefore, for a couple this could increase the amount of an estate that can be passed on tax free to £1 million by a combination of the standard nil rate band and the new main residence one. However, the new MRNRB will be phased in from the 2017/18 tax year at £100,000 and then increase at £25,000 per annum until 2020/21. Additionally, you can only claim up to the value of your main residence and the relief tapers once your total estate exceeds £2 million.
The rate of inheritance tax is then calculated as 40% on anything that is above the thresholds - so for a single person's estate worth £750,000, which includes a property with a value of at least £175,000, the amount of inheritance tax due will be £100,000, as this is 40% of the difference (750 - 500 = 250) - although this can be reduced to 36% if you leave 10% or more of your estate to charity.
Both the standard and main residence nil rate bands can be inherited by a surviving spouse if they were not used on first death. Generally, most wills pass all the deceased's estate to the surviving spouse. Therefore it is possible that there will be a £1 million allowance available from 2020/21 onwards.
Inheritance tax can also be payable on gifts you make in your life, and usually fall into one of the four categories listed below:
- Always tax-free
- Potentially tax-free
- Taxable, and tax is paid when the gift is made
- Taxable, but the tax is not due when the gift is made
A gift is deemed to be anything that has a value, such as money or possessions, or can be deemed as a loss in value when something is transferred. For instance, the difference in value when a parent sells a house to their child for less than the property is valued at is also classed as a gift. It is important to note, however, that any gifts given between married couples or civil partners living in the UK permanently do not incur inheritance tax.
The seven-year rule is employed to determine whether or not inheritance tax has to be paid on a gift. This means that the original owner of the gift (in whichever form it takes) must live for seven years after giving the gift for it not to count towards the inheritance tax threshold. If gifts were made less than seven years prior to the person's death, then inheritance tax is due, although the rate of tax is reduced for gifts given between three and seven years before they passed away if a gift in excess of the nil rate band was given - a reduction known as taper relief. If the gift was less than the nil rate band, there is no taper relief and the full amount would be liable to tax.
Paying inheritance tax
Inheritance tax is usually paid by the executor of the will (those named in the will to deal with the estate) or the administrator of the estate (the person who deals with the estate if the deceased has no will), using funds from the estate.
This means that people who receive an inheritance are normally not required to pay inheritance tax, although they may need to pay certain other taxes, if applicable.
Mitigating inheritance tax
Some families may end up paying more inheritance tax than is necessary. This is because there are certain ways to mitigate the tax, ensuring your loved ones receive all of the assets you would like to pass on to them.
One of the most effective routes to take is to make sure you reallocate some of your assets at the right time and within the allowances. This can be complex and is different for each person and their particular set of circumstances, which is why it always pays to seek expert help.
At Equilibrium, we have the skills and experience to make sure you don't end up paying more inheritance tax than you have to. By speaking to us, you can ensure the assets you worked so hard to accrue will be passed on to the people of your choosing. Read more about this subject by visiting our inheritance tax planning page here.
Get in touch today by calling us on 0808 156 1176 or fill out our online enquiry form and we will get back to you as soon as we can.