Inheritance Tax (IHT) is something many of us will have to think about at some point in our lives. Perhaps you’ve been updating your will, deciding who gets the house when you’re gone, or how much to donate to your favourite charity.
But before you know it, you can find yourself lost in jargon and legal terms. We’re here to give you guidance on thresholds, allowances, rates and exemptions, so you can plan your estate with confidence.
It's importantant to remember that tax rules are subject to change and depend on individual circumstances.
What is Inheritance Tax?
Inheritance Tax is paid on your estate when you die. And by estate we mean everything you owned at the time of your death, including your house, possessions and money.
Who pays Inheritance Tax?
In short, it depends. If you’ve named someone in your will, they’ll be called an ‘executor’. If there’s no will, someone will be appointed as an ‘administrator’. This is normally a family member, or someone you were close to. So whether you’ve picked someone, or someone is chosen for you, they’ll be in charge of sorting your affairs and figuring out if any Inheritance Tax needs paying to HM Revenue & Customs (HMRC).
Any Inheritance Tax due will be paid by your executor or administrator using funds from your estate, unless it relates to a gift. Inheritance Tax on gifts is payable by the recipient of the gift, not the estate. You can find out more about making gifts below.
Inheritance Tax: What are the rules?
Thresholds and rates
At the moment, the tax-free threshold is £325,000, meaning Inheritance Tax won't be paid on the first £325,000 you leave to others.
Anything above this threshold is currently taxed at a rate of 40%, subject to other exemptions and reliefs that may be available.
Inheritance Tax allowances
Broadly speaking, Inheritance Tax allowances cover circumstances that might:
- lower your tax liability
- raise the tax threshold
- pass some of your allowance on to your partner.
We’ll have a look at each of these allowances in turn.
Gifts, the act of giving
Anything you give away that reduces the value of your estate counts as a gift. When you die, some of the gifts might still take your estate over the Inheritance Tax threshold. But depending on when you made the gift, it might be taxed at less than the normal rate of 40%. This is called taper relief.
| Years between gift and death | Tax due |
|---|---|
| 3 to 4 years | 32% |
| 4 to 5 years | 24% |
| 5 to 6 years | 16% |
| 6 to 7 years | 8% |
If you die between 3 and 7 years after you made a gift, and the value of that gift takes you over the threshold, the amount of tax that applies is reduced using the sliding scale below:
Here are a couple of scenarios that break down the numbers.
- You give your grandchild £75,000 during the summer of 2021 and die 4 years later with an estate worth £150,000. This means your estate won’t pick up an Inheritance Tax bill because the gift and value of your estate is below the £325,000 threshold.
- You give your best friend £125,000 to help them pay off their mortgage and die 6 years later with an estate worth £325,000. Your friend, not your estate, will need to pay tax on the £125,000 at 8%. So, the total tax bill that your friend will pay is £10,000.
There are some gifts you can make each year free from Inheritance Tax. These include:
- Gift to spouse or partner: Inheritance Tax is not payable on any gifts you give to your spouse or civil partner. This means you can gift your partner as much as you like in your lifetime, as long as they live in the UK permanently.
- Donations to charities: Anything you donate to charity isn’t taxed. And if your donations are equal to 10% or more of your overall estate, then the Inheritance Tax payable changes from 40% to 36%.
- Money from your income: You can give away a portion of your earnings or pensions to others, as long as you can still pay your bills, and live your life comfortably. This is because Inheritance Tax applies to your assets, not your income.
- Annual exemptions: The first £3,000 you give away each year doesn’t count towards your estate.
- Weddings: Typically, you can give a gift of up to £1,000 per person without the amount being included in the value of your estate. If one of your children is getting married this can be up to £5,000. For a grandchild or great-grandchild, you can gift up to £2,500.
The roof over your head
As mentioned above, your estate won’t have to pay a penny in Inheritance Tax unless its total value is over £325,000. And you can even increase the amount of tax-free allowance you have if you leave your family home to your nearest and dearest in your will.
Since 2017 it’s been possible to increase your Inheritance Tax threshold from the normal £325,000 to £500,000 if you leave your home to your immediate family. This includes your children or grandchildren, but not your nieces, nephews or cousins twice removed. During your Inheritance Tax journey you’ll see this referred to as the residence nil-rate band.
Here’s how it works:
- You have the standard Inheritance Tax threshold of £325,000 as of this tax year.
- You leave your home – worth £175,000 – to your children and increase your total Inheritance Tax threshold to £500,000.
- This means your estate won’t have to pay Inheritance Tax on the first £500,000.
Marriage, civil partnership and your estate
Anything you leave to your spouse won’t count towards your estate’s Inheritance Tax liability. Even if your estate is worth millions. But it’s worth keeping in mind this only applies if you’re married or in a civil partnership. If you’re cohabiting, you won’t get this benefit.
Any of your unused threshold gets added to your spouse’s, meaning a couple can currently leave £1m tax-free.
Valuing your estate
Estate planning is a great way to get all your affairs in order and support your family. Whether you’re thinking about putting a will in place, or you’re not sure where to start, you can find out more in our guide.
Need a helping hand with Inheritance Tax?
If all this talk of Inheritance Tax thresholds, rates and estates feels taxing, we suggest talking to a financial adviser. They’ll be able to sit down with you and go over your finances and assets to help make your financial puzzle pieces click into place. Please note, an adviser will charge for their services.
But if you already know your facts and figures, then give our Inheritance Tax calculator a go. It could help you plan ahead and get to grips with how much Inheritance Tax your estate will need to pay, if any at all.
You can find more information on paying Inheritance Tax on the Government’s website.