What is inheritance tax and how do we lower it
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Inheritance Tax in the UK is a tax on the estate of somebody who has died. This includes property, possessions and money. If you aren’t sure if you need to pay inheritance tax on something or if you want to find out more about property possession, then take a look below.
What Is Inheritance Tax
Inheritance Tax (IHT) is a tax levied by the government in the United Kingdom on the estate (the property, money, and possessions) of a deceased person. It is also known as the “death duty.” When someone passes away and leaves an estate with a total value above a certain threshold, known as the “nil-rate band” or “nil-rate allowance,” the estate may be subject to Inheritance Tax.
As of my knowledge cutoff date in September 2021, the current nil-rate band for Inheritance Tax in the UK is £325,000. This means that if the total value of the estate is below £325,000, no Inheritance Tax is payable. However, if the estate value exceeds the nil-rate band, the excess amount may be subject to Inheritance Tax at a rate of 40%. It’s important to note that the nil-rate band may be subject to change, and there are additional allowances and exemptions that may apply in certain circumstances, such as the “residence nil-rate band” for a main residence passed on to direct descendants.
Inheritance Tax is typically paid by the estate’s executor or administrator, and it is usually due within six months from the end of the month in which the death occurred. Failure to pay Inheritance Tax when it is due may result in penalties and interest.
What Is Inheritance Tax Threshold
The nil rate band (NRB), also known as the inheritance tax (IHT) is a term to describe the inheritance tax threshold. Right now, it’s set at £325,000 so anything above this, you’ll have to pay tax.
Here’s an Example of How Inheritance Tax could Affect You
So, what is inheritance tax and what is the inheritance tax threshold? Let’s say that your estate is worth £525,000 and you have an inheritance tax threshold of £325,000. The tax will be on the £200,000 left over. If the taxable amount is 40% then you would pay £80,000 as this is 40% of £200,000.
The NRB (nil rate band) is fixed until the year 2021 but it’s important to know that it might be increased if you are a surviving civil partner or if you are widowed. It is possible for you to transfer any nil rate band that you haven’t used yet, this is known as TNRB, or transferable nil rate band.
What is the Resident Nil Rate Band?
The RNRB is a top-up for the current nil rate band. It’s available for deaths that are after the 6th of April, 2017. In general terms, if the family home is left in your will to your children, or any other lineal descendants, then you will raise your threshold by £125,000, which means that you won’t have to pay tax on anything under £450,000 (the IHT of £325,000 plus the RNRB of £125,000).
If you want to be eligible then you need to make sure that you pass on your home, or at least a share of it, to either your children or your grandchildren. This includes any foster children, adopted children or step-children. It should be noted that this does not include siblings or nephews. Provided that these conditions are met, you can reduce any tax that is against the estate.
The resident nil rate band allowance allows an additional threshold of £125,000, but it is going to rise in increments, up to £175,000. This will then be in line with the consumer price index. You might be able to use any RNRB that has not been used from your civil partner or spouse’s estate if you are a surviving civil partner or if you are widowed.
How to Value an Estate
If you want to know how to value the estate, then you have to list the assets and also work out the value at the time of the death. You then need to deduct any liabilities and debts as well. It’s so important that you keep records of how much you have actually worked out, and back them up where possible. Assets include items such as land, property, jewellery, shares or even payouts from an insurance policy. Gifts need to be included, such as cash or even any other assets. This is only the case if they have been given away in the 7 years before the person actually died. You will also need to include gifts that were given before this period if the person still benefits from the gift. These are known as gifts that have the reservation of benefit- for example, if they happened to give away their house but still lived in it. Liabilities and debts do reduce the value of the chargeable estate, so you need to think about things such as mortgages, credit card debts and funeral expenses. Any costs that were incurred after the death, such as probate fees or solicitor’s fees cannot be deducted from the estate value because of IHT purposes.
Who has to Pay Inheritance Tax?
If there is a will then it will normally be the executor who arranges the tax. It should be noted that if there isn’t a will then it’s going to be the administrator of the estate who has to do this. IHT is for funds that come from the estate or any money that has been raised from the sale of any related assets. A lot of IHT tax is paid through the DPS scheme, or deposit protection scheme. This ultimately means that if the person who died had any kind of money in their bank or even in their building society account then the person who is dealing with the estate can easily ask for some or all of the IHT to be paid right from the account and through DPS.
When does Inheritance Tax have to Be Paid?
If you do have to pay inheritance tax, then you have to make sure that you have a reference number. You’ll need to have this around 3 weeks before you make the payment. It’s important to know that this can be done either by post or online. Inheritance Tax has to be paid by the 6th month after the person has passed. If the tax is not paid in this timeframe, then HMRC can legally start charging interest. The executors can choose to pay tax on certain assets and including property. This can be paid in instalments over 10 years, but the outstanding amount will be subject to interest. If the asset is sold before the tax can be paid, then the executors have to make sure that the instalments and the interest is paid at that point. If your estate is going to incur IHT, it’s a good idea for the executor to pay some of this tax within the first 6 months of the death. This is even the case if they aren’t done valuing the estate. This is called payment on account. When this is done, it will reduce the interest that might be charged if it happens to take longer to pay off the debts. If the executor or even the administrator happens to be paying the tax on their own account, then they might be able to claim it back from the estate. Of course, HMRC will refund the estate if any amount has been overpaid. The term probate means the right to deal with the deceased’s property, possessions and money. In Scotland on the other hand it is called confirmation.
If you have been put as the executor or even the administrator of the estate then you will need to send in and complete the estate as this helps to avoid any kind of penalty. You need to visit the GOV UK website if you want to get more information on this, as this will help you to pay the right tax and trust.
Inheritance Tax and Gifts
Some gifts are actually exempt from any kind of inheritance tax. This can include wedding gifts or even charitable donations. Relief can also be available on certain types of property as well. This includes business assets and farms. If the person who died happened to get a gift in the 7 years before then this is counted as being part of the estate. Of course, it’s important to know that the taxable amount does depend on the value of the gift and who it came from.
How to Reduce Tax
Trying to reduce the tax due on any kind of estate can be difficult, but in short, you can reduce how much tax you need to pay by leaving a good amount to a charity or even by putting your assets into some kind of trust for any heirs that you might have. You can also leave your estate to a civil partner and you can pay into a pension as well if you want. It may also be worth you trying to give away £3,000 in gifts every year as this will also help you with your payments.
Using Life Insurance to Pay your Inheritance Tax
Taking out a life insurance policy to try and pay your IHT bill can really make things easier for both you and your family. It will also help you to sort out your estate after your death as well. It should be noted that this can protect your home along with your other assets. It also gives you peace of mind knowing that you are not burdening any of your friends or family with a large tax bill when you do pass away. Of course, if you ever have any questions then it’s always worth talking with your advisor as they can then give you the help you need. Normally, IHT has to be paid before the probate can be issued. Where property is concerned, HMRC will accept staged payments while the property is waiting to be sold. A bank might release the money if it’s paid directly to HMRC as this will help them with their IHT bill. A delay in any kind of payment may mean that HMRC needs to charge you penalties on the amount that is owed. A lot of life insurance policies will count as part of the estate unless your policy is written in trust which can be done at absolutely no extra cost. Any money is paid out to your beneficiaries and not to the legal estate you have. Any payout here won’t count towards the threshold you have, and it will not be subject to any kind of IHT. It will not involve a lengthy probate process, and this means that your beneficiaries are going to get their money much faster. A whole of life policy is normally used just for this purpose as it will remain in force until the policyholder dies.
So how does it work?
You will set up an insurance policy and you will specify that it is held in a trust. If you don’t do this then the money from the policy is then counted as being part of your estate and this means that it will be subject to IHT. When you die, the policy will then payout to the main trust and this might be used to pay some or even most of your IHT bill. You may need to set your wishes in a letter as this will help you to guide your policy so that you can trust anyone to use the funds in the right way. Estate planning and tax planning can be complex so it’s a good idea for you to get the advice you need so that you can always make the best decisions for your situation. If you are thinking about using life insurance so that you can pay your policy, then there are a number of different ones that you can take out. This is a good way for you to learn how to avoid inheritance tax or for you to try and reduce the inheritance tax you pay.
Whole of Life Policy
The great thing about this policy is that it will last as long as you are alive. It only pays out when you die but this is only if you are able to keep up with the premiums. If you are interested in taking this kind of insurance out then you might be paying out premiums until you’re well into your 80s. Premiums are more expensive, the older you get but some whole-of-life plans charge you a fixed premium for a fixed amount of cover, so you will know how much the policy costs and the sum of everything else. You might find it difficult to get a level of insurance when you are older or even if you have a health problem.
If you choose to give assets away to your loved ones and not your spouse, then there’s the risk that if you die in 7 years, they might be left with a huge tax bill. This is quite a bad situation because the bill will normally fall to those who received the gift as opposed to the estate. When you have an Inter Vivos policy, which decreases over time, you can match any IHT liability on a transfer over the nil rate for the inheritance tax. This type of policy will last for a certain amount of time and it only actually covers you if you die within the time frame. After this, your policy will then expire so you have to keep this in mind.
Relevant Life Insurance
Relevant Life Cover can only be taken out by a company for its employee buts it’s actually a very good way of reducing your tax liability in more ways than one. Not only can you claim it as a taxable expense for the company but as it’s written into trust it’s outside of your estate. Therefore it doesn’t form part of the estate. You can read full detail on relevant life tax treatment here.
Premiums are Fixed at the Start of the Policy
You have to keep up with the premium payments for the duration of the policy so that it pays out when you die. So what other kinds of tax will your heirs have to pay on the inheritance? Your estate will only be distributed if all of the debts have been paid and if you have sorted out and paid your IHT as well. Depending on what your heirs are going to inherit, they might also have to pay income tax. This is if they inherit some kind of regular income. This can include share dividends, or in some instances, rent from a property. Capital Gains Tax is if they sell the inheritance, for example, if it’s a property. How much they will have to pay usually comes down to whether they pay the tax at the higher rate or the basic rate. If you aren’t sure about this then you need to speak with a tax advisor as they will be able to help you with any questions that you might have. If you have put your assets into a trust or if you are thinking about doing this then you need to think about how much tax, and what kind of tax you’re going to have to pay. If you don’t then you may find that things become very complicated and this can cause you issues in the future.
A tax advisor can advise you on the inheritance tax threshold and they may even be able to give you an inheritance tax calculator. If you want to try and reduce the amount of inheritance tax that you need to pay, then there are a number of things that you can do. Some of them include being able to make a gift to your partner.
Make a Gift
You can lower the amount of inheritance tax that you need to pay by simply giving away assets. You can also set up a trust or even change your will if you want. You also have to try and make sure that you are paying special attention to any of the legal details or even the tax consequences of the tax you are paying. If you are in a civil partnership or if you are married, then you can easily give away anything you own to your civil partner or even to your spouse. If your spouse was born outside the UK then the amount that you can gift to them might be limited. Your estate won’t have to pay inheritance tax on what the gift is worth.
Of course, there are various rules based on if your civil partner or spouse’s home is outside the UK. The rules are very complex and therefore you need to try and make sure that you get some advice if you can. When you do, you can then try to lower the amount of tax you might have to pay.
Family and Friends
If you give an asset or gift to a family member who is not your spouse or even your civil partner, then the value of your gift has to be included in your estate as this will be taxed. That being said, you have to remember that this is only going to be the case for around 7 years. If you want an example, then let’s say you want to give your children some money. If you live for another 7 years then this won’t be taken into account when you do your calculations for your inheritance tax. You can also give away a set amount of funds every single year and when you do, you won’t have to worry about paying any kind of tax on that either. For example, you can give away up to £3,000 per year to your children. Just make sure that you are aware that you might have to pay capital gains or insurance or tax on certain assets in your lifetime. If you have any questions then your lawyer or accountant may be able to give you some advice.
Put Things into a Trust
Another thing that you can do to help yourself is put money into a trust. If you put some of your property, investments or cash into a trust that your children and spouse can benefit from then they won’t be part of your estate when it comes to your inheritance tax. This can come with some benefits and you would be surprised at how much it could help you financially. For example, you could set up a trust for your adult children and then pay for your grandkids to have an education. You can also support a family member who has a disability if you want. You can actually set up a trust right away or you can establish one in your will. Of course, it’s important to know that there might be some capital gains consequences if you happen to transfer certain assets into a trust in your lifetime but you will have no liability for the capital gains Tax if you establish a trust in your will. You have to bear in mind that some types of trust are actually subject to their very own tax regimes and the trust might have to pay some kind of inheritance tax. Trustees are likely to be liable for the income tax at a rate of 45%. On top of this, you might also have to worry about paying capital gains tax which would stand at 28%. The rules that revolve around trusts can be somewhat complicated so it’s really important that you take as much advice as you can from the experts so that you can go on to make the best decisions.
Leave Something to Charity
Another thing that you need to do is leave something to charity. Charity is free of inheritance tax so this can be a fantastic way for you to reduce your bill because you would also be benefitting a great cause as well. If you happen to leave around 10% of your estate to charity, then this will significantly reduce how much inheritance tax is due on the rest of the money you have. The rate at which inheritance tax is 36% as opposed to 40%. The rate is set against the balance of the estate to the extent that it exceeds the available nil-rate band. Right now, this is £325,000 but it can be reduced or in some instances eliminated if you are able to make certain gifts within your lifetime. This might not seem like a massive saving, but it can mean that family or even friends can receive way more than they would otherwise. It also means that your charity of choice is going to benefit as well so do keep that in mind.
Take out some Life Insurance
You have to know that if you do take out a life insurance policy then this won’t reduce the amount of tax that you have to pay on your estate. The payout however might make it much easier for your family to pay the bill after you pass away. If you decide to go ahead with this option, remember that the life insurance payout has to go into a trust. If it doesn’t then this will make everything much harder for you and your family in the future. Setting this up is very easy to do and it shouldn’t take you much time, so it’s certainly an extra step that is well worth taking if you want to make sure that as much money as possible gets passed down to your family. If you need help setting up your life insurance so that it gets paid into the trust then your insurance provider should be able to help you out, while also advising you on the options that are available.
Of course, there really are so many things that you can do to try and give yourself the best chance at paying a reduced rate of tax, and if you follow the above tips then you can be sure to not only leave your family more but to also reduce the stress they are put under from a financial standpoint when you pass away. If you have any questions then you need to talk with your accountant or your financial advisor, as they will be able to advise you on your own personal situation while also assisting you with setting up any trusts. They might also be able to support your family with advice and support regarding your decisions when you pass away.
For more information on the latest updates from HMRC please check out the government’s official page.
Information regards to taxation levels and basis of reliefs are dependent on current legislation. Individual circumstances are not guaranteed and may be subject to change. The Financial Conduct Authority do not regulate trusts.