A guide to Inheritance Tax 2023
What is Inheritance Tax?
Inheritance Tax (IHT) is a levy applied to the estate of the deceased, which includes money, possessions and all property. This tax applies at a standard rate of 40%. The part of your estate above the exempt threshold of £325,000 is only assessed for Inheritance Tax.
How much is the Inheritance tax?
There is usually no tax to be paid if:
- the value of your estate is below the £325,000 threshold, known as the nil rate band
- you leave everything above the threshold to your spouse or civil partner, or
- you leave everything above the threshold to an exempt beneficiary, such as a charity or a community amateur sports club, or
- if you give away your home to your children or grandchildren, your threshold can increase to £500,000.
Interesting facts on Probate
Only 1 in 20 estates in the UK pay Inheritance Tax.
If the total value of your estate is more than £325,000, any sum above that amount could be subject to a tax rate of 40%, according to the HMRC.
So, if your estate is worth £525,000 and your IHT threshold is £325,000, the tax charged will be £200,000 (£525,000 – £325,000). The tax would be £80,000 (40% of £200,000).
Passing on your home to a Loved one
You can pass a home to your spouse or civil partner when you die, and there’s no Inheritance Tax to pay.
Leaving your home to another person in your will counts towards the estate’s value.
The Residence Nil Rate Band (RNRB) increases the tax-free threshold if one leaves their house to their children or grandchildren. This incorporates stepchildren, adopted children and foster children, though not nephews, nieces or siblings.
There are tapered home allowance withdrawals if your estate’s overall value exceeds £2 million.
This table shows the increases in the RNRB and the potential combined allowance:
- Tax Year nil rate Band (£) Resident nil rate band (£) Total for individuals (£) Total for couples (£)
It was announced in the Finance Bill 2021 that inheritance tax nil rate bands will remain at existing levels until April 2026.
Married couples and civil partners can pass on the unused threshold
Until 2026 the Nil Rate Band (NRB) is permanently fixed at £325,000. It can augment one’s NRB if widowed or a surviving civil partner. Additionally, couples can pass along any unused NRB upon the first person’s death to their partner.
This can double the amount of NRB available up to £650.000. This extra transferable element is known as the transferable nil rate band (TNRB).
You might also be able to use any unused RNRB from your spouse or civil partner’s estate if you’re widowed or a surviving civil partner. This can double the amount of RNRB available.
How to value the estate
To value an estate, you’ll need to:
- list all the assets and work out their value at the date of death, and
- deduct any debts and liabilities.
Remember to keep records of how you worked it out, such as the estate agent’s valuation.
HMRC can ask for records up to 20 years after Inheritance Tax is paid.
Assets include money in a bank, property and land, jewellery, cars, shares, a payout from an insurance policy and jointly owned assets.
These are also known as ‘gifts with reservations of benefit’. For example, someone gave away their house but continued to live in it.
Their debts and liabilities reduce the value of the chargeable estate of the deceased. These may include housing bills, loans, credit card debt, and funeral expenses.
But any costs incurred after death, such as solicitor’s and probate fees, can’t be deducted from the estate’s value for IHT purposes.
It can be not easy, so it’s worth getting advice to help you make the right decisions.
Who usually pays Inheritance Tax?
If there’s a will, it’s usually the executor of the will who arranges to pay the Inheritance Tax. If there isn’t a will, the estate administrator does this.
IHT can be paid from funds within the estate or money raised from the sale of the assets.
However, most IHT is paid through the Direct Payment Scheme (DPS). If the person who died had money in a bank or building society account, the person dealing with the estate can ask for all or some of the IHT due to be paid directly through the DPS.
Upon death, payments from a life insurance policy may be liable to inheritance tax. To circumvent this responsibility, designating the policy in a Trust could remove the tax and bypass the protracted probate process.
When the tax and debts are paid, the executor or administrator can distribute what remains of the estate.
If you need to pay Inheritance Tax, you’ll need to get a reference number at least three weeks before you make payment. This can be done by post or online.
The executors can pay taxes on certain assets, such as property, in instalments over ten years. But the outstanding amount of tax will still get charged interest.
If the asset is sold before all the IHT is paid, the executors must ensure that all instalments (and interest) are paid at that point.
If your estate is likely to incur IHT, it’s a good idea for your executor to pay some of the tax within the first six months of the death, even if they haven’t finished valuing the estate. This is called payment on account.
This will help the estate reduce the interest it could be charged if it takes longer to sell the assets to pay off the debts and taxes.
If the executor or administrator pays the tax from their own account, they can claim it back from the estate.
HMRC would refund the estate if it overpaid IHT when given probate. Probate is the right to deal with the deceased person’s property, money and possessions. In Scotland, this is called confirmation.
If you have been appointed the executor or administrator of the estate, to avoid punishment, you need to submit an account of the estate within one year of the death.
Inheritance Tax gifts, reliefs and exemptions
Some gifts and properties are exempt from Inheritance Tax, such as wedding gifts and charitable donations. Relief might also be available on specific property types, such as farms and business assets.
If the person who died gave a gift in the seven years before they died, it’s counted as part of the estate and likely to incur IHT.
How much tax is due depends on the value of the gift, when it was given and to whom.
How can I reduce the amount of tax paid?
Trying to reduce how much IHT is due on an estate is complicated. But, in short, you can reduce how much tax is paid by:
- leaving a legacy to charity
- putting your assets into a trust for your heirs
- leaving your estate to your spouse or civil partner
- paying into a pension instead of a savings account
- regularly giving away up to £3,000 a year in gifts.
- Lowering the inheritance tax (IHT) payable on an estate is intricate. However, to summarize, you can reduce the burden of taxation by:
Buying life insurance to pay Inheritance Tax
Taking out a life insurance policy to pay some or all of an Inheritance Tax bill can make things easier on your family when it comes to sorting out your estate after your death.
You can use it to keep your property and other possessions from having to be sold to pay an Inheritance Tax bill, which must typically be paid before probate is given.
Thus, you’ll have the confidence that you are not leaving your relatives and friends with a large tax obligation to cover after you pass away.
Typically, IHT needs to be paid before probate can be issued. But where the property is concerned, HMRC might accept staged payments until the property is sold. Or a bank might release money if it’s paid directly to HMRC to pay an IHT bill.
A delay in payment can result in HMRC charging penalties and interest on the amount of the inheritance tax which should have been paid.
Most life insurance policies will count as part of the estate unless your policy is written ‘in trust’, which can often be done at no extra cost when taking out your policy.
Any money is paid to your beneficiaries, not your legal estate. So any payout won’t count towards your threshold and won’t be subject to IHT. This would avoid a lengthy probate process, so your beneficiaries will get their money quicker.
A whole-of-life insurance policy is often used for this purpose, which remains in force until the policyholder’s death, as long as you continue paying the premiums.
How these policy work
- You set up an insurance policy.
- You specify the policy is held in trust. If you don’t, the money from the insurance payout is counted as part of your estate and subject to IHT.
- When you die, the policy pays out to the trust, which might be used to pay all or part of your IHT bill. You might need to set out your wishes in a side letter to guide your policy trust trustees to use the funds in this way.
Estate and tax planning can be complicated, so it’s worth getting advice to help you make the right decisions for your situation.
- This policy lasts as long as you live and generally only pays out when you die, provided you keep up with the premiums.
- If you want this kind of insurance, bear in mind you might be paying premiums well into your 80s and 90s. Premiums are more expensive the older you get. However, some whole-of-life plans charge fixed premiums for a fixed amount of cover, so you know how much the policy costs and the sum assured at the outset.
- You might also find it difficult to get insured when you’re older or have had health problems.
Term insurance policy
If you gift assets to loved ones other than spouses, there’s a risk that if you die within seven years, they could be left with a large tax bill. This bill will often fall on the person who received the gift rather than the estate.
- An Inter Vivos policy, a decreasing term insurance policy, can provide a lump sum payout on death to match any IHT liability on a potentially exempt transfer over the nil rate band for Inheritance Tax.
- This policy lasts a set amount of time and only pays out if you die within the stated period. After that period, your policy will expire.
- Premiums are usually fixed at the start of the policy.
You need to keep up with the premium payments for the duration of either type of policy so it pays out when you die.
What taxes do my heirs have to pay on their inheritance?
Your estate is only distributed after debts (if any) and Inheritance Tax is paid.
Depending on what they inherit, your heirs might also incur:
- Income Tax – if what they inherit produces a regular income (such as share dividends or rent from a property)
- Capital Gains Tax – if they sell their inheritance (such as property) for more money than it was worth when they died. How much they must pay depends on whether they pay Income Tax at the primary or higher rate.
If you have placed your possessions into a trust or are contemplating such action, the amount of taxes and the kind of taxes they must pay can become quite complex.
It’s worth speaking to a tax adviser or solicitor for help working this out.