Inheritance tax (UK)

3 key takeaways

• Inheritance tax (IHT) in the UK is charged at 40% on the value of an estate above the nil-rate band, which is currently £325,000.
• Several exemptions and reliefs, such as the residence nil-rate band and charitable donations, can reduce the amount of IHT payable.
• Effective estate planning, including gifting assets and setting up trusts, can help minimize IHT liability and ensure more of the estate is passed on to beneficiaries.

What is inheritance tax?

Inheritance tax is a levy on the estate of a deceased person. The tax is calculated based on the total value of the estate, including property, cash, investments, and personal possessions, minus any debts and liabilities. The tax is only due on the portion of the estate that exceeds the nil-rate band.

Nil-rate band and rates

Nil-Rate Band: The standard nil-rate band is £325,000. This means that the first £325,000 of an estate is not subject to IHT.

Rate: The standard rate of IHT is 40% on the value of the estate above the nil-rate band.

Reduced Rate: If 10% or more of the estate is left to charity, the IHT rate is reduced to 36%.

Exemptions and reliefs

Residence Nil-Rate Band (RNRB): An additional allowance of up to £175,000 is available when a residence is passed to direct descendants (children or grandchildren). Combined with the standard nil-rate band, this can increase the total tax-free threshold to £500,000 per person.

Spouse or Civil Partner Exemption: Transfers between spouses or civil partners are exempt from IHT. Additionally, any unused portion of the nil-rate band and RNRB can be transferred to the surviving spouse or civil partner, potentially doubling the tax-free threshold.

Charitable Donations: Gifts to registered charities are exempt from IHT, and leaving 10% or more of the estate to charity reduces the overall IHT rate to 36%.

Business and Agricultural Relief: Certain business assets and agricultural property can qualify for relief, reducing their value for IHT purposes by 50% or 100%.

Annual Gifts: Individuals can give away up to £3,000 each year free of IHT. Additionally, small gifts of up to £250 per person per year and certain other gifts, such as wedding gifts, are also exempt.

Example of inheritance tax calculation

Example: Estate Valuation and IHT Calculation

An individual passes away, leaving an estate valued at £800,000. The estate includes a primary residence valued at £400,000, which is left to their children.

• Nil-Rate Band: £325,000
• Residence Nil-Rate Band: £175,000 (assuming full allowance)
• Total Tax-Free Threshold: £500,000
• Taxable Estate: £800,000 – £500,000 = £300,000
• IHT Payable: £300,000 x 40% = £120,000

In this example, the IHT payable on the estate is £120,000.

Planning strategies to reduce IHT

Gifting Assets: Regular gifting of assets during one’s lifetime can reduce the value of the estate. Gifts made more than seven years before death are generally exempt from IHT.

Setting Up Trusts: Trusts can be used to manage and protect assets while potentially reducing IHT liability. Various types of trusts have different IHT implications.

Charitable Donations: Leaving a portion of the estate to charity can reduce the overall IHT rate and benefit worthy causes.

Life Insurance: Taking out a life insurance policy in trust can cover the potential IHT liability, ensuring that beneficiaries receive their inheritance intact.

Challenges and considerations

Complex Rules: The rules governing IHT are complex, and navigating exemptions, reliefs, and planning strategies can be challenging without professional advice.

Valuation of Assets: Accurately valuing the estate and its components is crucial for determining IHT liability and ensuring compliance.

Family Dynamics: Estate planning and decisions about asset distribution can be sensitive and may require careful consideration of family dynamics and wishes.

Legislative Changes: IHT rules and thresholds are subject to change, so staying informed about current legislation is important for effective planning.

Related topics

• Estate planning
• Trusts and wills
• Tax planning
• Probate process

Explore these related topics to gain a deeper understanding of how to effectively manage and plan for inheritance tax, ensuring that more of your estate is preserved for your beneficiaries and aligns with your wishes.