It was Benjamin Franklin who in 1789 wrote “In this world nothing can be said to be certain, except death and taxes.” His words were as true then as they are now. Inheritance tax, often abbreviated to IHT, can be a significant charge on a person’s estate, and comes due at a time when a family may still be in grief.
In this article we will explain more about inheritance tax and how some simple, pre-emptive planning can help both reduce the tax and administration burden on those that you love.
Topics to be answered in this article
What is inheritance tax?
Inheritance tax (IHT), sometimes referred to as ‘Death Duty’, is a tax on the estate left behind by someone who has died. The estate includes items like property, possessions, shares, and money sitting in bank and savings accounts.
How much is inheritance tax?
The headline figure for inheritance tax is 40%, payable on everything in the estate over the value of a Nil Rate Band (NRB). In 2021, the NRB is £325,000 for a single person. This means that if the total value of a person’s estate, including property, possessions and money, came to £400,000, inheritance tax of 40% would be payable on £75,000. However, there are some exemptions and transferable allowances that can help reduce this.
How is inheritance tax calculated?
The final inheritance tax figure payable, is based on the net value of estate, less any applicable exemptions and transferable allowances. To value the estate, you need to include an estimate of the value of all assets, including bank balances, jewellery, shares, insurance policies, cars and of course property.
From this valuation, any debts can be deducted, such as household bills, mortgage payments, credit card debts, and funeral expenses. Unfortunately, costs incurred after death, including solicitor’s and probate fees, cannot be deducted from the estate’s value for inheritance tax purposes.
It is really important to keep a record of how the valuation was carried out, including details such as an estate agent’s valuation. HMRC can ask to see records for up to twenty years after IHT is paid.
Who pays inheritance tax and when?
Inheritance tax is due by the end of the sixth month, following the person’s death. Any delay will incur additional interest payments from HMRC. Where there is a valid Will in place, it is the executor who will arrange the calculation and payment of inheritance tax. If there is no valid Will, the administrator of the estate will do this.
Where does the money to pay the tax bill come from?
The actual money to pay the tax bill to HMRC, normally comes from funds within the estate, or money raised from the sales of assets such as shares. HMRC have a Direct Payment Scheme that allows the executor to pay some or all of the inheritance tax due from the deceased person’s accounts, to HM Revenue and Customs.
The requirement to pay IHT within six months, can often mean the need to sell more liquid assets quickly. The need for this can be avoided by advanced planning, such as having a life insurance policy in place. This can help ensure that sufficient cash is available to pay the likely bill in a timely manner, with minimum burden on the executor and wider family.
Tax free allowances
For the 2021-22 tax year, the tax-free inheritance tax allowance (nil-rate band) is £325,000. This allowance has remained the same since 2010-11. If the deceased was married, or in a civil partnership, then in most cases they can pass all possessions and assets to each other without incurring a tax bill. The surviving partner can then use both tax-free allowances. This may not be possible if the deceased used up their IHT allowance by giving away a large sum of money in their will.
There is also an additional allowance of £175,000 available if you are passing your home to a direct descendant. The Residence Nil Rate Band (RNRB) is available if you pass your home or a share of it to your children or grandchildren. This includes step-children, adopted or fostered children. It does not include nieces, nephews, or siblings. Any unused part for the RNRB allowance can also be transferred to a spouse or civil partner.
A combination of both the nil-rate band and residence nil rate band can give a total tax-free allowance of £1,000,000 for a married couple or those in a civil partnership.
How else can I reduce inheritance tax?
There are other things you can do in advance, to reduce your inheritance tax bill.
Gifting money or indeed a physical item in your Will, such as jewellery or art, to a qualifying charity, would mean not having to pay IHT on the item.
You can give away £3,000 worth of gifts each tax year without them being added to the value of your estate. This is known as your ‘annual exemption’. You can also give as many small gifts (up to £250 in value per person) as you want during the tax year, as long as you have not used another exemption on the same person. It is worth noting that gifts made within 7 years of the deceased dying, may be liable for inheritance tax. This is calculated on a sliding scale of between 40% and 8%.
Establishing a Trust for your assets, allowing heirs to benefit, without incurring IHT is also an option. This is likely to require professional help and advice, to formulate the Trust in the most effective manner.
Finally, one great option to reduce your inheritance tax bill is to spend more money whilst you are still alive. You have worked and saved hard to accrue the money that HMRC want to tax, why not spend some now and enjoy life to the full!
An increase in statutory legacy
As from 26 July 2023, the fixed sum, known as the ‘statutory legacy’, passing to a surviving spouse or civil partner when a person dies leaving children and without having made a valid Will, has been increased to £322,000. This has increased from £270,000 which has been fixed since February 2020
The intestacy rules provide for a deceased’s estate to be distributed in a certain way depending on the value of the estate and the surviving family members. If the deceased died leaving no children, then everything passes to the surviving spouse or civil partner and the statutory legacy does not apply. If the deceased had children, the surviving spouse or civil partner inherits the personal belongings, the statutory legacy and 50% of the remainder, with the other 50% passing to the children equally.
Where the deceased is unmarried with no children, the estate passes in accordance with a hierarchy of family members, depending on who survived the deceased. It is worth taking note that unmarried partners have no entitlement under the intestacy rules, even if they lived with the deceased as if they were married.
What to do next?
Inheritance tax planning is always best done as far in advance as possible. This allows the maximum benefit to be made from things like gifting to loved ones or making charitable donations. Ensuring that you have a Will in place, that correctly details your wishes, is also vital.
Discussing these wishes with your chosen executor and ensuring that you keep up to date with any changes in legislation and taxation, is also a good idea. Seeking early professional advice is often a good way to minimise longer term issues and problems. It may help reduce your inheritance tax burden too.
If you need help with your inheritance tax, make an appointment with one our tax planning solicitors and we can help you.