Inheritance tax can be complicated and subject to lots of misunderstanding and mistakes. Furthermore the topic can even be controversial and occasionally even inflammatory. However, as with all forms of tax, it’s vitally important to understand the fundamentals, especially when it applies to you. We have put together a simple, easy-to-understand guide to UK inheritance tax.
Inheritance Tax – How Does It Work
Inheritance tax (IHT) is levied on an estate that has been inherited. For example, if Adult A passes away and bequeaths £1 million to their child, Child B. This would mean that Child B will be liable to pay tax on the inheritance. However, inheritance tax only applies above a certain threshold. The normal threshold is £325,000. Although this can change in certain circumstances. In this instance of the £1 million inheritance, Child B would pay tax on £675,000 – i.e. only on the amount of inheritance over the £325,000 threshold.
When Does Inheritance Tax Not Apply?
No, inheritance tax is not due if:
- The deceased leaves their estate to their spouse or civil partner
- The deceased leaves everything above the threshold to an exempt beneficiary, such as a charity or a community amateur sports club
Any other beneficiaries of the estate – including children and other family members – must pay this tax. If the deceased leaves their home to their children or grandchildren the threshold can increase to £500,000.
What are the Rates and Limits of Inheritance Tax?
The basic rate of the tax is 40%. In the example we’ve used above, this would mean that Child B would pay £270,000. However, the threshold increases to £450,000 if the deceased person has given their home away to their children. A spouse or civil partner can ‘inherit’ the inheritance tax threshold of their spouse/civil partner. For example, if Mary and John are married and John dies without inheriting anything from anyone, Mary ‘inherits’ John’s threshold. This means Mary’s total threshold could be as high as £900,000. Inheritance tax can be reduced to 36% if 10% – or more – of the net value of assets in the estate are donated to charity. So if Adult A had donated £100,000 of their £1 million estate to charity, Child B would have inherited £900,000. They would only have to pay tax on £575,000 of this, due to the threshold. In this case the tax rate would be 36% rather than the standard 40%, which means they would pay £207,000 in tax. Other reductions and thresholds may be applicable, so seek professional financial advice as part of your planning.
Why do we Pay Inheritance Tax?
Inheritance tax represents a healthy income for the UK government. Despite this this form of tax is continually subject to much discussion and research as to potential changes. What people feel these changes should be varies across the political spectrum. The idea behind inheritance tax is that it is a way to redistribute wealth from generation to generation. In other words without inheritance tax inherited wealth is perpetuated, so wealthy families remain wealthy and with inheritance tax, wealth can be redistributed for wider benefit. Inheritance Tax can still come as quite a shock to those who are liable to pay the sum. If you have valued your estate at over £325,000 you might want to think about how you redistribute this after your passing away. Some ways to reduce inheritance tax are leaving a legacy to charity, putting your assets into a trust for your heirs, leaving your estate to a spouse or civil partner, paying into a pension instead of a savings account or regularly giving away financial gifts. There are limitations to be aware of so always seek professional financial advice.
Using Life Insurance to Pay Inheritance Tax
It is possible to take out a life insurance policy in order to pay some or all of an inheritance tax bill to make things easier on your family when it comes to sorting out your estate after you pass away. A life insurance policy can help protect your home and other assets from having to be sold in order to pay an inheritance tax bill, which must usually be paid before probate is granted. Life insurance gives you the peace of mind that you’re not leaving your family and friends with a hefty tax bill to pay when you die. Most life insurance policies will count towards the estate, unless your policy is written ‘in trust’, which can usually be done at no extra cost when you take out your policy.
How to Value the Estate
You need to list all the assets and work out their value at the date of death, and deduct any debts and liabilities. Assets include money in a bank account, property and land, jewellery, cars, shares, a payout from an insurance policy and jointly owned assets. Keep records of how you have calculated the value, such as an estate agent’s valuation. Be aware that HMRC could ask to see records up to 20 years after Inheritance Tax has been paid.
Prestige Business Management Works for You
At Prestige Business Management we can help you understand and manage your tax planning. Find out what we can do for you. Call us today on 0203 773 2927.