When writing your will, it’s important to consider the possible implications of Inheritance Tax. Let’s take a look at what Inheritance Tax is, who is responsible for paying it, and some of the ways you can reduce it.
What is Inheritance Tax?
Inheritance Tax (IHT) is a levy placed on properties, possessions and money that have been inherited from someone who has passed away.
Related: Everything you need to know about capital gains tax
Inheritance Tax rates
The standard Inheritance Tax rate is 40% and is only charged on the part of your estate that is above the threshold.
For example, if your estate is worth £400,000 and your tax-free threshold is £325,000, you will be charged 40% of £75,000 (400,000 minus 325,000).
Who pays Inheritance Tax?
If there is a will in place, it is usually the executor of the will who will arrange to pay the Inheritance Tax. If there is no will, the administrator of the estate will do this instead.
Funds from the estate can be used to pay IHT, or money raised from the sale of the asset. However, IHT is usually paid through the Direct Payment Scheme (DPS). Therefore, if the person who passed away had money in the bank or building society account, the administrator of the estate can ask for some or all of the IHT due to be paid from the account through the DPS.
Usually, Inheritance Tax is only charged if:
-
The value of the property is over the £325,000 threshold
-
You have not left everything above the threshold to your spouse, civil partner, a charity, or a community amateur sports club
When don’t you pay Inheritance Tax?
You can pass on your home to a civil partner or spouse without having to pay any Inheritance Tax. If your home is left to another loved one in your will, it counts towards the value of the estate.
However, if you leave your home to your children or grandchildren, the Residence Nil Rate Band (RNRB) can increase your tax-free threshold. This also includes stepchildren, adopted children and foster children.
RNRB is an extra amount that can be passed on after death without any Inheritance Tax being payable.
If either a husband or a wife leaves their estate to the other, the estate qualifies for 100% spouse exemption. Their unused RNRB allowance is preserved and can be transferred to the surviving spouse when they die.
This equates to a possible £350,000 Inheritance Tax-free allowance on the second estate (depending on the value of the property and of the estate at the date of the second death). This provides for a potential £140,000 IHT saving for children or grandchildren.
Related: How to protect your property from fraud
Passing on unused tax-free allowance
The Nil Rate Band (NRB) is currently fixed at £325,000, but this could be increased if your partner has passed away. If this is the case, you can transfer any unused NRB, and this is known as the transferable nil rate band (TNRB).
Can I reduce the amount of tax paid?
Reducing the amount of IHT due on an estate is a complicated matter and will depend on your circumstances. However, you can generally reduce how much tax is paid by:
-
Putting your assets into a trust for your heirs
-
Leaving a legacy to a charity
-
Regularly giving away up to £3,000 a year in gifts
-
Leaving your estate to a spouse or a civil partner
-
Paying into a pension instead of a savings account
Related: Moving on: Our advice on selling due to a divorce
How to use life insurance to pay Inheritance Tax
You may consider taking out a life insurance policy to pay some or all of your Inheritance Tax bill as this can make things easier for your family when it comes to inheriting your estate.
If your life insurance policy is written ‘in trust’, it will not count as a part of the estate, meaning that any money you left behind will be paid out to your beneficiaries and not to your legal estate.
Therefore, any payouts will not be counted towards your threshold and will not be subject to Inheritance Tax. This will ensure that your family avoids a lengthy probate process and will have quicker access to the money.
When setting up your insurance policy, it’s important to specify that it is held in trust. If you don’t, the money from your insurance pay-out will be counted as part of your estate and therefore be subject to IHT.
How to value the estate
An estate agent can provide a detailed valuation of the property. Bear in mind that you should also add any other assets left in their will such as money in the bank, jewellery, cars, or any payouts from insurance companies. From this point, you should deduct any debts and liabilities which need to be paid off.
Remember to keep all records which detail the value of the estate, as the HMRC can ask to see records up to 20 years after the Inheritance Tax has been paid.
For more advice, contact your local Ellis & Co agent
