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A guide to inheritance tax 

What is inheritance tax? 

Saarrah Mussa
Written by  Saarrah Mussa
5 min read
Updated: 06 May 2024

Inheritance Tax (IHT) is a tax applied to the value of the estate of someone who has died, this includes all possessions, including property and money. The current Inheritance Tax rate is 40% however, it is only applicable to the part of the estate that is above £325,000 – which is the current tax-free threshold.

Inheritance Tax (IHT): 

  • This is a tax on the total value of the deceased person's estate (assets minus debts) after their death. 

  • No IHT is charged if the estate value is below the current threshold of £325,000. 

  • If the estate exceeds the threshold, only the portion above it is taxed at a rate of 40%. 

  • It's important to note that you, as the beneficiary, don't pay IHT directly. The executors of the deceased's will are responsible for paying the tax before distributing the inheritance. 

When do you have to pay inheritance tax?  

You only need to be pay inheritance tax if the net value of the person’s estate exceeds the current threshold of £325,000. If the deceased entire estate which all are assets minus any debts, are less than £325,000, no inheritance tax is die.  

If the estate is above this threshold you usually have within 6 months of the death to pay the taxable amount (405). This can often be paid by the executors of the deceased’s will before any inheritance is distributed amongst the beneficiaries.  

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Who needs to pay inheritance tax?  

 If the deceased has a will, it will usually be the executor of the will who arranges to pay the inheritance tax and this will be done before any beneficiaries receive their inheritance. The tax can also be paid by the administer of the estate and it can be paid with funds from the estate itself or from money raised from the sale of the assets of the deceased.  

Inheritance tax gifts, exemptions and reliefs   

Here's a breakdown of Inheritance Tax gifts, reliefs, and exemptions in the UK: 

Gifts: 

  • Annual exemption: You can give away £3,000 worth of gifts each tax year (April 6th to April 5th) without them being added to your estate for Inheritance Tax purposes. You can give this amount to one person or split it among several. Unused annual exemption can be carried forward to the next tax year, but only for one year. 

  • Small gifts: You can give gifts of up to £250 to as many people as you like each year, except to someone who already received your full £3,000 annual exemption. These small gifts are also exempt from Inheritance Tax. 

  • Wedding/civil partnership gifts: You can give tax-free gifts to individuals getting married or entering a civil partnership:  

    • £5,000 to your child or grandchild. 

    • £2,500 to any other descendant. 

    • £1,000 to anyone else. 

Reliefs: 

  • Taper relief: If you give away assets exceeding the annual exemption but die within 7 years of doing so, Inheritance Tax might be due on the gifted amount. However, "taper relief" reduces the tax you pay based on how long you lived after giving the gift:  

    • Gifts within the last 3 years before death are taxed at 40%. 

    • Gifts between 3-7 years before death are taxed on a sliding scale, with the tax gradually decreasing the further back you go. 

Exemptions: 

  • Gifts to spouse/civil partner: Gifts to your spouse or civil partner (domiciled or deemed domiciled in the UK) are exempt from Inheritance Tax, regardless of the amount. 

  • Charitable donations: Gifts to registered charities are exempt from Inheritance Tax. 

  • Other potential exemptions:  

    • Business assets may qualify for Business Relief, reducing or eliminating Inheritance Tax. 

    • Agricultural land and buildings might be eligible for Agricultural Relief. 

    • Pensions generally pass outside your estate and are not subject to Inheritance Tax. 

It's important to note that Inheritance Tax rules can be complex.  

How can I reduce the amount of tax liability?  

  • Leave Assets to Spouse/Civil Partner: Assets left to your spouse/civil partner are exempt from IHT. 

  • Plan Early: The sooner you start planning your IHT strategy, the more options you have. 

  • Making gifts: You have an annual allowance for gifts that will go to waste and without using may subject your beneficiaries to a hefty IHT, which is why its important to plan early  

  • Gifts to Charity: Donations to registered charities are entirely exempt from IHT. Leaving 10% of your net estate to charity can even reduce the IHT rate on the remaining portion. 

  • Utilize Tax-Efficient Investments: Consider investments like Business Property Relief (BPR) qualifying assets or Agricultural Land and Buildings, which might be exempt from IHT. 

  • Pensions: Pensions generally pass outside your estate and are not subject to IHT. 

  • Life Insurance: Taking out a life insurance policy written in trust can provide your beneficiaries with a lump sum to cover IHT costs, preventing them from selling assets. 

  • Seek Professional Advice: Consulting a financial advisor or tax specialist can help you navigate the complexities of IHT and tailor a strategy to your specific circumstances. 

  • Review Regularly: Your IHT situation might change over time, so it's crucial to review your plans periodically and make adjustments as needed. 

How does life insurance help with inheritance tax  

Life insurance can be a valuable tool in mitigating Inheritance Tax (IHT) liability in the UK. Here's how: 

Providing a Lump Sum to Cover IHT: 

  • Whole-of-life insurance: This type of policy builds a cash value over time, which can be designed to specifically cover the estimated inheritance tax bill.  

    • Upon your death, the policy pays out a lump sum to your beneficiaries, allowing them to settle the tax owed without selling assets from your estate. 

Key Benefits: 

  • Preserves Assets: Your beneficiaries inherit your assets intact, avoiding the need to sell them to pay IHT. 

  • Flexibility: You can tailor the policy amount to match your estimated IHT liability. 

  • Peace of Mind: Knowing your beneficiaries have the means to cover IHT provides you and your loved ones with peace of mind. 

Important Points to Consider: 

  • Tax Implications: While the life insurance payout itself isn't subject to any inheritance tax, the payout becomes part of your estate. If the total value of your estate, including the life insurance payout, exceeds the IHT threshold, the remaining amount above the threshold might still be subject to tax. 

  • Policy Ownership: To ensure the payout isn't counted as part of your estate for IHT purposes, the life insurance policy needs to be:  

    • Written in trust with your beneficiaries as the named trustees. 

    • Owned by someone outside your estate, such as your spouse/civil partner. 

What taxes to expect when you get an inheritance  

While you generally don't pay tax directly on the inheritance itself in the UK, there are a few potential taxes you might encounter: 

  • Income Tax: Any income generated from your inheritance, such as dividends from inherited shares or rental income from a property, might be subject to Income Tax. You would pay tax on this income as you would with any other income source. 

  • Capital Gains Tax: If you sell an asset you inherited, such as a property or shares, you might be liable for Capital Gains Tax on any profit made from the sale. 

Here are some additional points to remember: 

  • Gifts within 7 years: If the deceased gave away assets exceeding the annual exemption (£3,000) within 7 years of their death, those assets might still be subject to IHT, calculated on a sliding scale based on how long they lived after giving the gift. 

  • Spouse/Civil Partner Exemption: Gifts received from your spouse or civil partner are exempt from IHT regardless of the amount. 

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