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What is inheritance tax and how does it work?

Taxation in the United Kingdom may involve payments to a minimum of three different levels of government i.e. The Central Government (Her Majesty's Revenue & Customs), Devolved National Government and Local Government. Inheritance tax falls under the jurisdiction of HMRC.

HMRC Inheritance Tax planning as quite clear by its name itself is a tax levied by the UK Government on the estate (money, possessions and the property) of someone who has died. Estate and Inheritance tax are quite similar because of the reason behind them which is death. Former one is applicable on the total value i.e. net value of the deceased person on the date of their death and later one is applicable on the recipients. Various countries around the globe have different inheritance tax rates. Japan has the world's highest inheritance tax rate at 55% whereas USA and UK stand second in the number at 40%.

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IHT threshold or nil rate band

IHT Threshold or Nil Rate Band (NRB) is the amount up to which IHT is not applicable. Each individual has their own NRB which means that their estate and taxable gifts are exempt from IHT up to a certain level /threshold, which currently is £325,000.

2022/23 2021/22

Standard threshold

£325,000

£325,000

Combined threshold maximum for married couples and civil partners

£650,000

£650,000

Rate of tax on balance

Chargeable lifetime transfers

Transfers on, or within 7 years of, death

40%* 40%

Individuals with direct descendants who have an estate including a main residence with total value of more than Inheritance tax Threshold i.e.£325,000 and personal representatives of the deceased individuals will have to pay the Inheritance Tax at the rate of 40% , which means:

Any part of the estate, which is left behind by the individual at the time of his death up to the IHT threshold is chargeable at the rate of 0% and part of the estate which exceeds the IHT threshold is chargeable to IHT at 40%.

IHT Nil Rate Band is applicable to all property together with any taxable gifts made within/before 7 years of death.

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Residence Nil Rate Band (RNRB)

The new IHT Residence Nil Rate Band (RNRB) was announced in the Summer Budget of 2015 and introduced in April 2017. It is in addition to an already existing individual’s own nil-rate-band of £325,000. However, it is applicable only on one condition that the main residence should be passed on to the direct descendants i.e. children or grand-children.

General description of nil-rate-band and residence nil-rate-band:

Tax Year Nil-Rate Band Residence Nil-Rate Band Total for an individual Total for a married couple/civil partners

2016/17

£325,000

Nil

£325,000

£650,000

2017/18

£325,000

£100,000

£425,000

£850,000

2018/19

£325,000

£125,000

£450,000

£900,000

2019/20

£325,000

£150,000

£475,000

£950,000

2020/28

£325,000

£175,000

£325,000

£1,000,000

The main idea behind introducing IHT Residence Nil-Rate-Band was to soften the blow of inheritance tax on the direct descendants and closed family members of the deceased individuals and by 2020/28, families should be able to escape IHT on up to £1M of their wealth because each parent will have a nil-rate band of £325,000 plus a residence nil-rate-band of up to £175,000 i.e. £500,000 per parent and £1,000,000 when combined.

Residence Nil Rate Band was not in effect until April 2017 and it was phased over 4 financial years. Like Nil Rate Band, Residence Nil Rate Band is transferable between spouses and civil partners on the occasion of death of one of the partner/spouse and it is the unused percentage of the residence nil rate band from the estate of the first to die which the second spouse can claim.

As its name suggests, it is applicable only if the main residence of the deceased individual is passed on to the direct descendants i.e. children (including foster, adopted or step) or grandchildren. However, in case there are multiple residences in the name of the deceased individual, it will be down to the personal representatives to select/nominate one residential property out of many available. It is not necessary that the deceased individual owned the residence at the time of death. Chances are there that he could have moved to his relative’s house etc in the process of downsizing his estate. Residence nil rate band will still be applicable in this case provided the property disposed of was owned by the individual and it would have qualified for the Residence Nil Rate Band had he retained it.

It is always good to keep reviewing your will(s) constantly to cater for changing circumstances, taxation rules and policies.

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Inheritance tax rates & inheritance tax in 2023

The United Kingdom has the 2nd highest Inheritance Tax Rate after Japan. The standard Inheritance Tax is 40% and it is only charged on that part of asset, over and above the declared threshold value, i.e. £325,000.

Hypothetically, if the net worth of assets is £650,000, so IHT charged will be 40% of £325,000 (Net worth amount – Threshold Amount)

However, IHT is reduced to 36% on certain assets if 10% or more of the net value has been given to the charity as per the will.

Summer budget of 2015 introduced a new provision which allowed individuals and married couples to pass on to their main home with a smaller tax liability. It introduced a new measure to reduce the burden of IHT for the families by making it convenient to pass on the family home to the direct descendants without any tax. It was then decided to set a new limit in April 2017 which will eventually allow each individual to pass on estates valued up to £500,000 without any tax.

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Who pays the HMRC inheritance tax

As mentioned above, Inheritance Tax is paid to HMRC after the death of an individual. In case there is a will declared by the deceased, it’s on the executor of the will to arrange for the IHT. In the UK, the person who is making the will can appoint up to four executors, so that the responsibility of IHT can be mutually shared. It also ensures that the property of the deceased person is in safe and secure hands immediately after his/her death.

For the year 2017/18, everyone is allowed to leave an estate of worth up to £425,000, which includes normal nil rate band/threshold up to £325,000 plus additional residence nil rate band of £100,000. However, this additional residence nil rate band is applicable only if the residence of the deceased individual is passed on to the direct descendants.

If there is a will declared by the deceased person, then depending on who has got what and its estate value, he or she has to pay the IHT. It’s your heirs who must pay the inheritance tax by the end of six months after the death of the person. However, to pay the Inheritance tax, you need to get Inheritance Tax Reference Number from HMRC at least 3 weeks prior before you make the payment.

You need to fill up Form IHT422 to apply for Inheritance Reference Number along with form Form IHT400 (in case the death has happened after 18th March 1986). You can either apply or fill the forms online or you can send them by post to the postal address mentioned on the form.

In case there is no will declared by the deceased, the administrator of the estate has to make the necessary arrangement for payment of necessary IHT. Chances are high that the individual has planned well in advance for the payment of IHT through various sources like Life Insurance Policy. In any other case, IHT is paid from the money left in the estate, in case there is any or from the money raised by the sale of assets.

Smart cheat guide to save/avoid IHT: how to give more to your family and less to the taxman:-

Without proper and prudent Inheritance Tax planning, you would be leaving less for your beneficiaries and more for the taxman, HMRC in the UK. In recent years, more and more families have been stung by Inheritance Tax after steep rises in house prices. However, with a little bit of advance planning, you can ensure that the people you actually wanted to get benefit from your estate, do get that benefit after your death. Following are some tips from the expert financial planners that can help you avoid the pitfalls that surround IHT: -

1. Write a will :-

Setting up a will should be your first step in IHT Planning, not only to make certain that matters are dealt with in a tax-efficient way but also to ensure that your wishes are carried out in a proper and efficient manner. Even if you have a will, it must be up-to-date and reflect your wishes, assets and current tax position in a clear manner. Any kind of civil partnership, marriage, divorce or dissolution can have an impact on your will.

In case a person dies without declaring his/ her will, then he is said to have died intestate and it gives birth to a lot of issues.

Effectively it’s the Law which decides what happens to the estate, which can lead to financial anxiety for the surviving spouse. In most cases, HMRC becomes the largest beneficiary of your estate.

2. Calculate your actual IHT liability

Irrespective of how obvious it sounds, it’s actually quite a prudent step to consider and know well in advance where all IHT is applicable for you to plan better. As per current IHT threshold and nil-rate-band, every individual has a tax-free allowance of £325,000. IHT is applicable on the value of the estate over and above this value at the rate of 40%.

Calculating your potential IHT liability:

ASSETS ESTIMATED VALUE

Value of main home

£

Other properties , business, property / land

£

Car(s), boat, etc

£

Household contents and personal effects

£

Bank and Building Society Accounts

£

Investments ( stocks & shares , bonds, offshore accounts, ISAs )

£

Life Insurance Policies (if not under trust )

£

Pension Lump sum ( if not under trust )

£

Other assets, including gifts

£

SUB-TOTAL

£

Less any liabilities:

Mortgage(s)

£

Loans, hire purchase, credit cards

£

SUB-TOTAL

£

Calculating your IHT Liability

Subtract available nil-rate-band, taking into account any transferrable unused allowance from deceased spouse or civil partner and any residence nil-rate-band available to you

Subtract any exemptions (Refer point 3 )

Balance

£

X 40% ( potential liability)

3. Gifts and exemptions from inheritance tax

The main approach to IHT mitigation is to reduce the value of your estate over a period of time. The smaller the value of your estate when you die, the less your IHT bill is likely to be. There are a lot of ways for doing so, few of them are listed below:-

1. Pass your estate to your spouse / civil partner:- Married couples and civil partners are allowed to pass their estate to their spouse tax free. In other words, the surviving spouse can inherit the entire estate without paying any IHT (unless your spouse was born outside the UK, in which case the amount you can give away might be limited.

What if I am not married to my partner:

In case of married couples, transfers of property and other assets don’t attract inheritance tax, however this is not the case with unmarried individuals. If you are not married but own the assets jointly with your partner, then your liability to pay the IHT will depend on whether you and your partner own the property as joint tenants or tenants in common or if there is a will. Even if your partner has left everything on your name in his/her will, his or her family members would still have a claim to your partner’s share of assets like insurance policies and pensions investments.

1. Annual Exemption

Individuals are entitled to give away £3,000 in total, in any tax year without any IHT applicable on it. In case, in one tax year the full amount of £3,000 is not utilized, it can be carried forward to the next. This means that a married couple could give away a total of £6,000 a year to their children without incurring any IHT and a total of £12,000 if the previous year’s allowances were unused.

2. Small Gift Exemption :-

Gifts up to £250 in total, to any number of people in one year, are exempted from IHT. However, it cannot be a part of any larger gift.

3. Marriage or civil partnership gifts exemption :-

Gifts made in consideration of a marriage or civil partnership can be considered for IHT exemption, however amount of gift varies on the type of donor, as described below:-

DONOR AMOUNT

Parent

Up to £5,000

Grandparent

Up to £2,500

Others

Up to £1,000

4. Normal Expenditures from Income :-

To benefit from this particular exemption, the gifts need to be made regularly i.e. yearly and it has to be out of true income i.e. dividends and interest from investments. There is no maximum limit on the amount which can qualify for this exemption and it can only be worked out on death of an individual.

5. Other Exemptions :-

Lifetime gifts for the upbringing of children and other dependents, if any, are free from IHT liability. Few other exempts on gifts and bequests are as below:

  • to charities
  • to political parties
  • to universities
  • for national purpose
  • for public health

6. 7-year rule : ( Benefit of Tapering) :-

If a person gives away more than £3,000 each tax year - or the other exemptions - and dies within seven years of making that gift, leaving an estate worth more than the nil rate band, it is eligible for inheritance tax.

Years Between Gift and Death Tax Paid

Less than 3 years

40%

3 to 4 years

32%

4 to 5 years

24%

5 to 6 years

16%

6 to 7 years

8%

7 or more

0%

4. Make use of trusts

Another intelligent way to mitigate your IHT is to use trust. If you put some of your cash, property or investments into a trust, which you, your spouse and none of your children under 18 years of age can benefit from, they’re no longer part of your estate for IHT purposes. However, there are certain trusts which are subject to their own tax regimes and they might have to pay IHT themselves.

One can put all manner of assets in the trust, including investments, life assurance policies and death benefits.

If trust has been established correctly, it not only helps you in reducing your IHT liability by transferring your assets progressively out of your estate but can also give you access to regular income while you are alive, in the form of withdrawals. The rules around trusts are a bit complicated and there are lots of factors that come into play so it is always better to take expert Inheritance Tax accountants advice.

5. Gifts to charity :-

If you leave some or entire estate to a charity, it can help in reducing your IHT and in some cases, it might even eliminate IHT liability. However, you can choose to donate to a charity while you are alive or you can allocate the desired amount in your will. If you leave something to charity in your will, then it’s called a charitable legacy.

In case you have allocated 10% of your net estate to a charity, then in that case IHT rate can cut down to 36% from 40% on the rest of your estate value.

6. Tax Reliefs :-

Certain assets are exempt from Inheritance Tax and if they are not exempted, IHT is charged at reduced rate. Exemptions of these kinds are known as tax reliefs. Few of them are listed below:-

1. Business Relief : Depending on how you own the business and its type, you can get either 50% or 100% tax relief on it.

2. Agricultural Property Relief : You can pass on a farm free from IHT, however not all farms fall under this category.

3. Woodland Property: If you leave a woodland property, the land itself is not subject to Inheritance Tax. But the trees on the property are subject to the tax if it’s sold or given away as timber.

The executor of your estate will have to include the value of the woodland when applying for probate even though it’s not considered for Inheritance Tax.

4. Heritage Assets: If you own a building, land, or objects of national scientific, historic or artistic importance, you could claim relief from Inheritance Tax.

Conclusion

HMRC inheritance tax, mostly called death tax, is triggered by death and its payable on the net value of estate (money, possessions, property) of an individual on his death. However, careful and advance planning with help of an expert financial advisor will help you to utilize and distribute your estate between your loved ones. There are various financial firms whose services you can avail for better planning of your Inheritance Tax Liability and Tax.

One of such renowned firms is dns accountants, who have created a niche for themselves in the market with their expert domain knowledge in taxation and financial accounting. At dns accountants, with its team of expert taxation professionals and Inheritance Tax Accountants, they have been helping individuals with their queries on Inheritance Tax.

The primary concern/issue behind IHT planning is that they should be able to pass on as much as possible to the desired benefactors without imposing much liability on them.

The politics behind IHT are amongst the most controversial around whereas the basic idea was to redistribute the income so that some of the money goes to the state to get further redistributed for the benefit of all. However Government policies and regulations keep on changing and it is difficult for a normal citizen to keep pace with it and this is where dns accountants have their expertise on. Their guidance/ service covers:

  • Advice on IHT and family wealth succession.
  • Calculations and predictions of IHT.
  • Guidance on Capital Gains Tax Liabilities.
  • Guidance on transfer of gifts with pre-owned assets.
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Answers to IHT planning’s most frequently asked questions

Got questions?

An inheritance tax accountant can advise you on several tax-saving opportunities with IHT. Due to the complexity of this tax, it is essential to understand it better. By this, you can make it easy for your estate and will not be considered a burden.

Yes, a financial advisor can help you minimize your inheritance tax bill. There are several ways to save or reduce your inheritance tax that an advisor can suggest to you better.

Yes, there are several ways to avoid inheritance tax. A few of them are here which you can use to avoid and pay less inheritance tax:

  • You can give gifts while you're still alive
  • You can leave money to charity in your will
  • Write pensions and life insurance policies in trust
  • You can leave everything to your partner's name
  • You can leave the house to your children

Yes, you can put your house in your children’s name to avoid inheritance tax with some terms and conditions. If you give away your house to your children and live for at least seven years afterwards, no inheritance tax will be applicable. If you die within these seven years, inheritance tax will be paid according to the sliding scale. Consult with Inheritance Tax Accountants to know more in detail.

There are a few circumstances when HM Revenue and Customs (HMRC) will contact you if you are due for any inheritance tax. If

  • You received a gift seven years ago from the person who died
  • The dead person put assets in a trust, and the trust doesn't and can't pay
  • The deceased person's representative couldn't or didn't pay before you received your inheritance.

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