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Inheritance Tax planning

Not every estate will be subject to Inheritance Tax (IHT), but it’s important that you take it into consideration when you are writing your Will.

Our guide explains what Inheritance Tax is, if your estate will be subject to it and how you can reduce your death taxes. 

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What is Inheritance Tax?

Inheritance Tax is a tax that is paid from the estate (possessions, money and property) of someone who has died. Very few people actually pay it, with just eight per cent - or around 41,000 families - of the UK parting with any money in 2016/17, according to the Office for Budget Responsibility.

What is the Inheritance Tax threshold?

The basic Inheritance Tax allowance is £325,000 (until 6th April 2021). No tax has to be paid on an estate if the total value of the estate value is under this threshold. 

Married couples and civil partners are able to leave their estates to each other without being subject to Inheritance Tax, they can also pass on any unused tax free allowance.

For example, if Mr Smith dies and leaves everything to Mrs Smith, she can add his £325,000 allowance to hers, increasing her Inheritance Tax threshold to £650,000. Therefore, she can leave an estate worth up to £650,000 without it being subject to Inheritance Tax. 

Anything above the £650,000 threshold would be taxed at 40%, although additional tax relief is available if you are giving away your house as part of your estate.

How is Inheritance Tax calculated?

The standard tax rate is 40 per cent of everything outside of the threshold of £325,000. For example:

Estate A

  • Value: £450,000
  • Amount of taxable estate: £125,000
  • Amount of tax due: £50,000

Estate B

    • Value: £225,000
    • Amount of taxable estate: None
    • Amount of tax due: None

The tax rate may drop to 36 per cent if at least ten per cent of the estate is left to a charity.

Also, giving away your house can increase your Inheritance Tax threshold to £475,000. As of 6th of April 2019, everyone in the UK has an additional £150,000 tax free allowance that can be used against the value of their home. This is classed as the “main residence” allowance and can only be used if you leave your home (main residence) to your children or grandchildren.

This allowance is set to rise by £25,000 per year, rising up to £175,000 by 2021. Therefore, by 2021, a married couple could leave their heirs a combined estate of up to £1 million without incurring any tax! 

Who is responsible for paying the Inheritance Tax?

Inheritance Tax is paid from the estate, either with money left by the deceased or raised from the sale of assets. In some instances, there could be a life insurance policy left behind to cover the Inheritance Tax.

If there is a Will, then the executor is responsible for making sure the correct amount of tax is paid and if there isn’t a Will, the administrator must do this. Once the tax bill and other debts have been paid, the estate can then be distributed among the beneficiaries.

It usually needs to be paid to HMRC within six months of the death and if it isn’t, interest will be added to the total amount due. More time can be given to the executor if certain assets, such as property, need to be sold beforehand. In this instance, the Inheritance Tax can be paid in yearly instalments and will still be subject to interest.

It is important to remember, that even if the estate’s value is below the threshold it still needs to be reported to HMRC.

Can I reduce the Inheritance Tax?

There are a few ways to reduce how much Inheritance Tax is due on an estate. These include:

  • Leaving an entire estate to a spouse or civil partner
  • Paying money into a pension rather than a savings account
  • Giving away £3,000 in gifts a year
  • Leaving a gift to charity in your will
  • Putting assets into a trust for your heirs

It is always recommended that you have a Will in place, not only does this ensure that your estate is divided according to your wishes, but it can also be used to ensure that any death taxes are minimised and the Inheritance Tax payable is reduced.

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