The passing of a parent or loved one is an extremely difficult time. Having to deal with their affairs on top of everything can add more stress too.
With large sums of money potentially at stake, it's important to get the right information, advice, and help. In this article we'll cover the basics of inheritance tax, and answer a few of the common questions.
For more help, please contact us directly and we'll help put you in touch with the best professionals for the job.
So first of all, what is inheritance tax?
Inheritance Tax is a tax on the property, money and possessions of someone who has passed away. The property, money and possessions of the person who has died is collectively known as the person’s “estate”.
The amount of Inheritance Tax to pay depends on:
- The value of the estate (what everything is worth),
- The relationship between the deceased and the person inheriting,
- The tax law and thresholds at the time.
First, we'll cover the tax thresholds.
1. Inheritance tax threshold
One of the first questions usually asked is "how much money you can inherit before paying taxes on it?"
The standard Inheritance Tax threshold in the UK is £325,000. This means that if the value of your estate is less than £325,000 then there is normally no Inheritance Tax to pay.
The next most-asked question is usually how to avoid paying inheritance tax. In other words, in what situations will you be exempt from paying it?
You can avoid paying Inheritance Tax if either:
- The value of your estate is below the £325,000 threshold (which is known as the Nil Rate Band).
- Or you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club.
Where you leave your home, money or possessions to someone other than your spouse or civil partner, it will count towards the value of the estate, and the beneficiaries will need to pay inheritance tax on it.
1.1. What is the Residence nil-rate band?
Your Inheritance Tax-free threshold can increase from £325,000 to £500,000 where you leave your home to your children or your grandchildren. The extra £175,000 is known as the “Residence Nil Rate Band” (RNRB).
("Children" includes adopted, fostered or stepchildren too).
Residence nil-rate band for very high-value estates
Your estate must be worth less than £2million in order to benefit from the maximum RNRB. If your estate is worth £2million or more, the RNRB allowance will decrease by £1 for every £2 above £2million that your estate is worth.
1.2. What happens to any unused threshold?
As we've covered, the threshold for inheritance tax is currently £325,000. But what if you die leaving less than this? You'd have unused tax-free threshold remaining. This can be used in the future, which will mean your beneficiaries may still pay less tax.
You can add any unused threshold to your partner’s threshold when you die where:
- You are married or in a civil partnership with your partner; and
- Your estate is worth less than your threshold (which will either be £325,000 or £500,000 if the RNRB is applicable).
This is known as the “Transferable Nil Rate Band” and means your partner’s threshold can be increased to as much as £1million.
Transferring unused RNRB
When it comes to transferring tax allowances, the RNRB and basic Inheritance Tax thresholds are not linked. This means that even if all of the basic Inheritance Tax threshold was used when the first spouse/civil partner died, you can still transfer the unused RNRB.
1.3. Reporting the estate’s value
Remember that you will need to report the estate’s value to HMRC, even when this is below the £325,000 threshold. You can report the estate’s value on the Government's website here.
So we've covered the situations where you won't need to pay inheritance tax rates. But what happens when you do?
2. Inheritance tax rates
The standard Inheritance Tax rate is 40%. This is charged on the part of your estate that exceeds the thresholds we covered above.
A reduced rate of 36% applies where you leave 10% or more of the “net value” of your estate to charity in your will. We have set out the various rates for you below:
*The Nil Rate Band (£325,000) and Residence Nil-Rate Band (£175,000) figures will both remain frozen until April 2026.
Colin and Amanda are married.
Colin passes away leaving an estate worth £600,000:
- He leaves £97,500 to his child,
- The rest is left to his wife, Amanda.
The available threshold at the time was £325,000.
The legacies to the child would use up 30% of the threshold (£97,500/£325,000 x 100 = 30%), leaving 70% unused.
The rest is passed tax-free to Amanda, as they were married.
When Amanda dies, imagine the threshold set by the Government is still £325,000. Amanda’s available threshold would increase by the unused percentage (70%) to £552,500. (£325,000 + (£325,000 x 70%) = £552,500).*
If Amanda’s estate is not worth more than £552,500 there will be no Inheritance Tax to pay when she dies.
Let’s say Amanda’s estate is actually worth £600,000 though. The IHT payable would be £600,000 - £552,500 x 40% = £19,000.
3. Reliefs and exemptions
There are certain situations where you'll get tax reliefs or exemptions, meaning you won't have to pay as much tax.
Certain reliefs may apply to reduce the amount of IHT payable (sometimes to nil) where you leave gifts of certain types of asset, including:
- Business property relief - applied automatically and available for both lifetime gifts and on death. (See more about business property relief here).
- Agricultural property relief - applied automatically and available for both lifetime gifts and on death. (See more about agricultural property relief here).
Follow the links above to the GOV.UK website to find out more.
Gifts to certain individuals or bodies are exempt from IHT and do not use up the NRB, including:
- Gifts to a spouse or civil partner (provided you both live in the UK)
- Gifts to charities - and remember, if you leave 10% or more of your net estate to charity, the reduced rate of IHT will apply (36%)
If none of the above exemptions apply, there are also additional exemptions available for lifetime gifts. The most commonly used exemptions are:
- Normal expenditure out of income - provided the donor if left with sufficient income to maintain his/her usual standard of living. There must be a regular pattern of giving, so an example of this would be meeting annual school fees for grandchildren.
- Small gifts - lifetime gifts of up to £250 to any one individual during a tax year are exempt. If the gifts to one individual exceed £250, the small gifts exemption does not apply to any part of the gifts. You cannot carry forward any unused portion to the next tax year.
- Wedding and civil partnership gifts - the exemption is not available if the ceremony doesn’t take place, and it must be paid on or before the ceremony.
Wedding and Civil Partnership Gifts
In the case of Wedding and civil partnership gifts, the limit depends on the relationship of the donor to the couple, as follows:
- Each parent can give £5,000
- Each grandparent can give £2,500
- Either of the couple can give to each other £2,500
- Any other person can give £1,000
- Annual exemption - lifetime gifts (which do not fall into any of the above exemptions) are exempt up to £3,000 a year. Any unused portion of the annual exemption can be carried forward for one tax year only.
Potentially exempt transfers (PETs)
PETs are called “potentially” exempt, because if the donor survives for seven years from the date of the gift, the gift becomes fully exempt.
Where the donor dies before the seven years is up, the gift will become chargeable and will use up all or part of the donor’s NRB. However, the longer the donor survives after making the gift, the lower the IHT (provided the donor survives at least three years from the date of the gift).
This is known as “taper relief” and is calculated as follows:
The taper relief is applied to the IHT due and not the value of the gift. We have set out an example below:
4. Who pays the tax to HMRC
The person dealing with your estate, known as the “executor” if there is a will or “administrator” if you die without leaving a will, will be responsible for arranging payment of any Inheritance Tax due to HMRC.
Payment will usually be made using funds from your estate.
4.1. Paying inheritance tax when inheriting a home
Q: Will I personally have to pay Inheritance Tax if I inherit a home under a Will?
A: No, beneficiaries of a Will are not usually responsible for paying Inheritance Tax. It is the executor’s or administrator’s responsibility to pay Inheritance Tax out of the estate to HMRC.
Once the tax has been paid, the assets will be distributed to the beneficiaries as set out in the deceased’s Will.
4.2. Situations where you'll personally need to pay the tax
However, you may personally have to pay Inheritance Tax in the following circumstances:
- if the deceased’s estate can’t or doesn’t pay it;
- if you inherit assets outside the UK or inherit any assets the deceased cannot dispose of by Will (e.g. jointly owned property passing by survivorship); or
- on a gift the person gave you in the 7 years before they died.
HMRC will contact you if you need to pay any Inheritance Tax.
5. Deadline to pay inheritance tax
The deadline to pay Inheritance Tax is by the end of the sixth month after the person passed away. For example, if the person died in March, you must pay Inheritance Tax by 30 September.
If you miss the deadline, HMRC will charge you interest on the outstanding amount.
You will need to obtain an inheritance tax reference number from HMRC before you can make payment and this should be applied for at least three weeks before the deadline.
The government have created a handy guide to paying your Inheritance Tax bill here.
7. How we can help
The passing of a parent or loved one is an extremely difficult time. Having to deal with their affairs on top of everything adds more stress. There can be large sums of money at stake, and significant tax payments as we've outlined here.
We recommend getting the advice and help of a qualified professional, and can help put you in touch with best people.
Call us now on 0330 223 5568 for free guidance, and we'll help get you started.
By Matthew Cooper, Founder of Home Selling Expert