UK Inheritance Tax

UK Inheritance Tax

Inheritance tax or IHT, is a tax which was created by most states for people that inherit property or money. Inheritance tax bill is given to the person who receives the property, and his or her duty is to pay that bill. Usually, the inheritance tax is charged at 40% above a threshold. The inheritance tax threshold in the UK is set at £325,000.

Inheritance tax in the UK is usually paid if the value of the inheritance is more than £325,000. The threshold will increase to £500,000 if you give your home to your children, including your adopted, foster, or stepchildren. 

If you leave everything to your husband, wife, or partner, then they will not pay any tax. 

Inheritance Tax UK Overview

UK inheritance tax was introduced back in 1986, and it replaced the capital transfer tax. According to the Tax Foundation, the United Kingdom tax has the fourth highest inheritance rate in the world. But, the tax is only paid by a very small proportion of the population.

Inheritance tax is 40% tax and it is applied when a person dies. It is applied when the inheritance is worth above £325,000. The tax will be charged more, but that will be based on how much property was left.

If you transfer your property to a relative or someone you know, then based on the reasons, you might be able to transfer almost everything without paying tax.

Who Pays Inheritance Tax?

In some cases, the person who dies might have left a will. If he or she did that, then the tax would have been paid. But, if there is no will, then the person who inherits the property will have to pay the tax.

The inheritance tax can be paid in two ways. The first way is by paying it by funds that you get from the property. The second is by selling the property and paying the tax with the money. In practice, tax should be paid through the Direct Payment Scheme. This means that if the person who died had money in the bank, then the person who inherits the property can ask for some of the money to pay the tax.

In most cases, the person who died has left money for the inheritance tax. Typically, this is covered by a life insurance policy. Payments from the life insurance policy can be used to pay the inheritance tax. Once all of the taxes and debts are paid, the person who inherited the property can divide the rest of the estate.

When to Pay Inheritance Tax?

The inheritance tax must be paid within six months of the person’s death. If the inheritance tax is not paid by then, HMRC will start charging interest. The people who own the estate can choose to pay the tax month for month for the next ten years. But they will still get charged interest on what is left to pay.

It is better if you pay some of the tax within those six months, even if the process of valuing the property has not been completed yet. It will help the estate reduce the interest that you will be charged if you take too long to pay the IHT.

In some cases, inheritors can choose to pay the tax from their money, which later can be recovered by the estate. If you are in charge of the property, then you should complete and send in an account of the estate within a year after the death to avoid penalty.  

How Much is Inheritance Tax in the UK?

How much is inheritance tax UK, is a very important thing to know. Inheritance tax is 40% tax which will be given to the inheritor of the whole estate if it is worth more than £325,000. The tax can be more, but that would be in some special cases, for example if you sell your home.

There are some helpful strategies that you can use to reduce the size of the estate or increase your NRB. The NRB, also known as nil – rate band, is a tax-free allowance of £325,000. 

What is included in the estate?

If you are wondering what will be included in your estate for the importance of inheritance tax, then these are the things:

  • Savings
  • Possessions and property
  • Pension funds 
  • Physical and intangible UK assets
  • Land and real estates
  • Investments
  • Collections
  • Furniture 

The first £325,000 of the estate is tax – free, so the 40% will only apply when something goes over this particular value.

Estates Management

The estate is usually managed very easily. In most if not all cases, it is divided between family members of the person who died. This type of transferring the wealth from one generation to another within the family is a way of dividing property for more income. It is typically done in very rich families. 

Please remember that it is better to hire an estate attorney. As you may already know, inheritance taxes can be very hard and complicated to deal with. Hiring an estate attorney will be of great help. The attorney will make sure that your inheritance taxes are paid correctly.

7 Year Rule

The amount of tax that you have to pay will be decided by how long you can survive after creating the gift. The amount will change over the lifetime of the 7 tax year period. This is known as the Taper relies. The following table will show you how this rule works:

Time since the gift was createdReduction in inheritance tax
0 – 3 yearsNone
3 – 4 years20%
4 – 5 years40%
5 – 6 years60%
6 – 7 years80%
7+ yearsNo charges

Note: If you still benefit from the gifts after 7 years, then it will be included in the estate, and you will be charged with tax. For example, let’s say you give your house to someone, but you keep living there without paying rent. 

Informing HMRC if You Inherit Money

When you inherit something, you might not need to pay tax right after. But, you might have to pay tax a little later. That is because you need to pay income tax on the profits that were made from the assets that you inherited. 

If you had received a gift and the inheritance tax was not paid by the person who gave it to you, then you will have to pay it yourself. If you cannot pay the tax, then the bill will be charged from the inheritance. 

IHT and Pension

Pensions can be a way of not paying inheritance tax. For example, if you do not use your pension savings, then when they are given to your heirs, they will have to pay taxes.

Sadly, it is not the same as defined – benefit pensions. If you die before the age of 75, then no tax will be paid. If you die after the age of 75, then those who inherit your property will have to pay the tax. The tax charged will be based on what they receive. 

Pension savings are not in the same category. They are not considered to be a part of your estate and the inheritance tax. Because of this, pensions should be considered when saving for a later life. You should remember that the yearly allowance for a pension is £60,000.

Avoiding Legally Inheritance Tax

Everyone in the UK has to pay inheritance tax if the size of the entire estate is more than the basic threshold of £325,000. 

The threshold, also known as nil – rate band is currently set at £325,000, but it might change in the future. The basic rate for inheritance tax is 40% of everything above the nil – rate band.

Please remember that if your estate is valued at more than £325,000, that does not mean that the inheritance tax bill will be due to your death. Avoiding inheritance tax legally or reducing the amount that you have to pay is possible with some planning.

Writing a Will

As mentioned above, a person might leave a will. Writing a will could be a way of managing who will pay the inheritance taxes. In most cases, if there is a will then it would mean that the person who died already paid the inheritance taxes.

If you are not familiar with what a will is, then you are in the right place. Will is a legal document that has instructions on how the property of a person should be divided after their death. A will could also decide the custody of minor children.

Whether or not the will is authentic, will be determined through a court process known as a probate. During the process, it will be proven if the will is truly made by the person who died. The court will appoint an executor, who will have the power to act on behalf of the person who died.

Giving Money as a Gift to Children Before Death

If you want to give money as a gift but not pay tax, then that is also possible. But, it is possible only for amounts up to £3,000 per year. If it is not used one year, then the next year you can double it and give £6,000.

If you can show that the gift was made through income, then you do not need to pay inheritance tax. You can also give money as a wedding gift without paying inheritance taxes.

However, there are some cases where someone gives a bigger amount of money, then passes away seven years later. In this case the money might be used as a part of the estate when calculating the inheritance tax.

Using a Trust

Some parents might make a trust fund for their children. If they do so, then they will no longer be owners of those assets, so they will not pay any inheritance tax. But, there are different types of trust funds, and every type has different rules. If you want to create a trust fund for your children, then you will need to find out what those rules are.

When the assets are in the trust fund, a trustee will manage it. The assets will no longer be yours, so they will not be considered when valuing most estates for inheritance tax. But, this will be seven years after placing the assets into the trust fund. If you remember, in the 7 year rule section, this was mentioned in the table.

Please remember that before putting the money or any assets into a trust fund, you need to know the rules and implications involved in the process. Before making a decision on whether or not to set up a trust fund for your children, you can consult with an expert for more information.

Changing the Size of the Estate through Gifts

One of the ways to reduce the size of your estate and the inheritance tax is to either give away or gift your property. It might help to improve the finances of younger people, but it will take too much planning. Gifts can be categorized in two ways:

  1. Gifts that are tax free immediately
  2. Gifts that drop out of your estate after a period of time (7 years)

Gifts that are tax free immediately

Usually, tax free gifts are gifts between spouses, partners of gifts given to charities. Before giving a gift or giving something away, it is important to consider what you need in order to live a good life after giving it. This means that you should give only what you can live without.

You should not risk your retirement income. You need to be sure about what you can give away. But, consulting with an IFA (International Fiscal Association) or with a financial planner, would be very helpful. This will help you when you decide what to give away.

Spending Money

If you are wondering what the simplest way of legally avoiding inheritance tax is, then it is spending money. You can try to spend your money on yourself or on your family while you are still alive. You can go on a vacation or buy yourself something that you always wanted.

Gifts to Charity

As mentioned above, one of the ways to avoid legally inheritance tax is by giving it to charity. If you leave a gift that will be considered a charity, then you will no longer pay inheritance tax. This gift can be money, property, or any kind of asset. If you do this, you will be able to reduce the size of your estate and pay less inheritance tax.

You can reduce the 40% rate of insurance tax by charitable gifts. If you leave at least 10% of the entire net value of your taxable estate (not gross value) to charity, then whatevers stays above the threshold will be reduced at 36% inheritance tax.

Lifetime Gifts

A common way of avoiding legally inheritance tax or reducing it, it would be through lifetime gists. This way is done by giving money or assets before you die to those who will be your heirs. This will help the assets reach your family members with zero tax.

There are three categories of a lifetime gift:

  • Exempt transfers: Gifts which are usually below a certain amount, which can be made at any time and are not counted for the inheritance tax.
  • Potentially exempt transfers: Gifts that do not meet the criteria of the exempt transfer but will not be considered for the inheritance tax if it is given seven or more years before your death.
  • Chargeable lifetime transfers: Gifts that are neither exempt nor potentially exempt. They will also not be considered for the inheritance tax.

Other Inheritance Tax Reliefs

There are other ways to help reduce the inheritance tax bill. 

  • Business relief: Another possibility is to claim a relief that can reduce the value of the business or the assets when evaluating an estate for the purposes of inheritance tax.
  • Agricultural relief: Another form of inheritance tax relief which can be claimed by transferring agricultural property. This could potentially be a good option.

Conclusion

Inheritance tax is very complicated, so you might want to consult with a professional. Remember that currently the Inheritance tax is charged at 40% above a threshold. Additionally, the inheritance tax threshold in the UK is currently set at £325,000.

There are some strategies that you can use to avoid legally paying the inheritance tax. Whether you will leave a will or testament, or you will divide the property before your death, you need to understand how the whole process works.

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