A UK Guide to Inheritance Tax
As Benjamin Franklin once said, "nothing is certain except death and taxes". And it turns around that even in death, we cannot escape taxes.
Inheritance tax is levied on the estate, namely the property, money, and possessions owned by an individual when they die. In the UK, IHT is currently charged at 40% on an individual's estate above £325,000, the "nil-rate band" threshold.
In this article, we will provide all the detail you need to understand inheritance tax and tips on reducing your IHT liability or the amount of your estate subject to this tax. This article provides an overview, but for detailed advice, please consult a professional who will be able to assist you further.
Our Inheritance Tax Calculator is on hand to help you determine what tax your estate may be subject to.
What is inheritance tax?
Inheritance Tax (IHT) is a tax on the estate of someone who has died, including all property, possessions and cash.
The UK's standard IHT rate is 40% and the tax-free threshold is currently £325,000. This means an estate is only subject to the 40% tax on its value above the £325,000 threshold (the "Nil Rate Band"). Estates valued below £325,000 are not subject to IHT.
Worked example of inheritance tax
If an estate is worth £1,000,000 and the tax-free threshold is at the standard £325,000, the IHT charged will be £270,000.
First, you must take the estate's value minus the threshold. In this case, it is £1,000,000 - £325,000.
This leaves £675,000 as the amount subject to IHT. This figure is then multiplied by 40% (the standard IHT rate).
This total tax paid in this example is, therefore, £270,000.
Things to note for IHT
IHT can be complex, which is why it is always best to seek counsel from a professional. However, this article has noted some critical stipulations below.
- An estate is not usually subject to IHT if everything above the threshold is left to a spouse, civil partner, a charity, or a community sports club.
- Gifts to qualifying charities of any value are exempt from IHT. If an individual leaves 10% of their net estate (the 'baseline amount') to charity, IHT reduces from 40% to 36%.
- All assets passing between spouses and civil partners during life and on death are exempt from IHT as long as they are domiciled in the UK.
- The £325,000 allowance can be inherited by a spouse (married) or civil partner on death. The surviving spouse or civil partner can then gain a tax-free allowance of £650,000.
- In addition to the standard "nil-rate band", there is the "residence nil-rate band" (RNRB). This can be applied to estates that include a family home, and it is an additional amount over-and-above the standard "nil-rate band" if the home is passed to a direct descendent (such as children or grandchildren). It is currently set at a maximum of £175,000 per person and is fixed until April 2026. This allowance has been fixed until April 2026 and is also transferrable between spouses and civil partners, as the standard "nil-rate band" is.
How to value your estate
To value your estate, you'll need to make a list of your assets and liabilities. The estate's value is the total value of assets minus the value of the liabilities.
Assets
Your assets are items of value that belong to you. These include:
- Bank accounts
- Pensions
- Properties
- Valuable Items (e.g., jewellery and art)
- Vehicles
- Investments and shares
- Jointly-owned assets
- Insurance policy pay-outs
Gifts, in the form of cash or other assets, made within seven years of your death are also considered when looking at your estate's total value. All gifts made to individuals more than seven years before your death are disregarded.
Liabilities
Conversely, liabilities are what you owe to others. These include:
- Personal loans
- Mortgages
- Credit cards
- Student loans
- Unpaid taxes
Who pays inheritance tax?
Your estate will pay the inheritance tax, and the remaining money and assets are split between beneficiaries as decreed by your will. The executor of the will or administrator of the estate will usually organise the inheritance tax payment. It must be paid within six months of your death.
How to decrease your inheritance tax liability
With intelligent estate planning, you can reduce the amount of inheritance tax and maximise the assets you leave to your beneficiaries.
Give gifts every year
Gifts given within seven years of your death will still count as your estate and be subject to inheritance tax. However, there is a yearly allowance of £3,000 that you can gift IHT-free. This is the total, not per person.
Give gifts of up to £250 per person
You can give up to £250 per person tax-free each year. You cannot combine this with the £3,000 gift allowance, so whoever receives some of the £3,000 cannot receive a further £250.
Leave money to charity
Money left to charity will not be taxed. Work out your charitable contributions wisely to avoid the £325,000 tax threshold.
Wedding gifts
Wedding gifts given shortly before or on the day of a wedding or civil partnership are tax-free. The couple's parents may give up to £5,000 tax-free, grandparents up to £2,500, and anyone else up to £1,000. If the wedding does not go ahead, then you cannot give this money tax-free.
Putting the money in trust
When you put money or assets into a trust for your heirs, it is not counted as part of your estate and therefore is not subject to IHT. This money may be used to finance a house, education, or even provide an income. The beneficiary may be subject to income tax or capital gains tax but will avoid inheritance tax.
Leaving money over £325,000 to your spouse or registered civil partner
Because these assets are jointly shared through the nature of your relationship, they are not subject to inheritance tax. Take advantage of this exception and leave any remaining amount over the threshold to your partner.