Inheritance Tax, or IHT, is the tax which is payable on your estate when you die.  Your estate includes your home, your car, your bank accounts, investments and anything else in your name.  It also includes gifts made during the seven years before your death.  

Whether inheritance tax is payable will depend on a number of factors such as the current inheritance tax threshold, any gifts you've made in the past seven years, and whether your spouse or civil partner is inheriting all or part of your estate. 

On this page:

• Planning for Inheritance Tax
• Inheritance tax exemptions
• Gift exemptions
• Potentially Exempt Transfers (PET)
• Taper Relief
• Calculating inheritance tax
• Inheritance Tax Threshold
• Paying inheritance tax
• Life insurance policies
• More information

Planning for Inheritance Tax

Writing a Will allows you to reduce significantly the amount of inheritance tax charged on your estate, or even eliminate it altogether.  Some gifts can be given to people and organisations without inheritance tax being charged on them.

Through careful planning, you can ensure that you take advantage of the tax-free allowance available and you may be able to give away your assets to family, friends and relatives with very little if any inheritance tax charged

Inheritance Tax Exemptions

Spouse and Civil Partners

If in your Will you decide to leave all your assets to your husband, wife or civil partner, and you are both domiciled in the UK then no inheritance tax would be due as these people are 'exempt beneficiaries'.  However, if your permanent home is in the UK but your wife, husband or civil partner lives outside the UK then you are only able to leave them £55,000 tax-free in your Will.  Anything over this amount would incur inheritance tax charged at 40%.

If you leave your entire estate to your spouse or civil partner, later when your partner dies, tax on the two estates (yours and your partner's) would be charged inheritance tax on any amount over the threshold.  The current threshold or nil-rate band for married couples or those in a civil partnership is £650,000 (tax year 20011-12). 

Individuals

Individuals are able to leave up to £325,000 in 2011-12 to anyone in their Will without having to pay any inheritance tax.  Any amount under the current threshold of £325,000 is referred to as the nil-rate band.  Money or specific possessions can be left to a partner, relative or friend without inheritance tax being charged, providing the value of the gift does not exceed the nil-rate band.  Any amount over this threshold would be charged inheritance tax at a rate of 40%.  The number of people paying inheritance tax is increasing each year, due to the rise in house prices.  However, the threshold usually rises on a yearly basis.

Living Abroad

If you move abroad or retire outside of the UK, you may still be required to pay inheritance tax.  You are only considered non UK domiciled if you have lived outside the UK for more than three years.  If you are not UK domiciled then only your UK based assets would be liable for inheritance tax.  However, depending on the country you are living in, your assets there may also be taxable.

Gift Exemptions

There are types of gift that are exempt from tax and allow people to pass on large parts of their estate to friends and loved ones, in order to avoid paying large sums of inheritance tax.  These gifts are exempt regardless of how long you survive after giving them.

Annual Exemptions

Each tax year you are permitted to give a large gift of up to £3,000 to one individual.  If you have not used up the £3,000 tax-free gift allowance by the end of a year, then the remaining balance can be carried over once to the next tax year.

Wedding/Civil Partnership Gifts Exemption

Gifts given to either partner on their wedding or civil partnership are exempt from inheritance tax, provided their value is below a certain limit:

Parents can give up to £5,000,
Grandparents / relatives can give up to £2,500,
Any other individual can give up to £1,000.

Providing the gift is given before the ceremony it will be tax-free.  If the ceremony is called off then the gift will not be tax-free.  

Small Gifts Exemption

Small gifts of £250 can be given to as many separate individuals as you like in any one tax year (April 6th to April 5th), without any tax being charged.  If the gifts are made seven years before your Will takes effect then they will not be included in your estate and will be tax-free.  It is not possible to combine a 'small gift' with the 'annual exemption' to give gifts of a higher value, without paying tax.  However, you can use your annual exemption with any other exemption.  Therefore, you would be able to use your £3,000 annual exemption and your £5,000 wedding gifts exemption, to give your child £8,000 as a marriage gift.  This would mean that no tax would be charged on these sums, providing you survive seven years after having made the gift.

Maintenance Gifts

Tax-free maintenance gifts can be given to your spouse, ex-spouse, civil partner, any relatives who are dependent due to old age or illness, and any of your children who are under eighteen and in full time education.

Gifts to charities and political parties

If in your Will you wish to leave money or any of your assets to any UK registered charity, then no inheritance tax is payable on these amounts.  Some people choose to leave money to a museum, gallery, National Trust or political party as well as other charitable institutions.  

Normal Expenditure

Any gifts from your income after tax which form part of your normal expenditure, and do not reduce your average standard of living, are not liable for tax.  These include birthday presents, Christmas presents or payments into a life insurance policy.  It is advisable to check with a tax expert before making a regular gift to check whether it would qualify as tax-free with HM Revenue and Customs.  

Potentially Exempt Transfers (PET)

A PET is only inheritance tax free if you make the gift more than seven years before your death.  However, there are tax reductions for gifts made three or more years before your pass away, which are known as Taper Relief.  

Trusts

Gifts of money paid into a trust for children or grandchildren, where the beneficiary can only access the trust fund once they reach eighteen, are also exempt from tax, providing you survive seven years after making the gift.  

However, payments to other types of trust including current or newly established trusts will incur inheritance tax charges.  Gifts to trusts are classified as chargeable lifetime transfers.  If the amount remaining in the trust when the donor has passed away is more than the current threshold of £325,000 then tax would be due at 20%.  A further 20% would also be charged if the donor passed away less than seven years after making the gift. 

Taper Relief

If you pass away less than seven years after making a gift, you may be eligible for a reduction in the tax payable.  This is referred to as 'Taper Relief', which means that the tax on the gift would be less than the standard 40%.  

Years since making the gift	Reduction	Inheritance Tax % charged
0-3 years	0%	40%
3-4 years	20%	32%
4-5 years	40%	24%
5-6 years	60%	16%
6-7 years	80%	8%

 

 

Calculating Inheritance Tax

Inheritance tax is calculated after any gifts to your spouse, civil partner, registered charities or political parties have been deducted.  The executor will need to work out the value of your estate after the relevant deductions, and then organise for the inheritance tax to be paid.  This will have to take place before your assets can be passed on to the beneficiaries.  When calculating the value of a person's estate their assets are priced at the market value.

To calculate the inheritance tax due on the estate, the executor will first need to value the estate.  Any gifts made in the seven years before the death (although some may qualify for Taper Relief) will also form part of the estate.  Having done so, any funeral expenses, mortgages or other debts will then need to be deducted from the estate before the final value of the estate can be found.  Depending on whether the net value of the estate is above or below the threshold for the tax year, inheritance tax may or may not be payable, see Inheritance Tax Exemptions.

Inheritance Tax Threshold

A little like Income Tax, Inheritance Tax is calculated according to 'bands'.  While Income Tax has several bands, Inheritance Tax has just two bands: the 'nil-rate band', which is the portion of the estate on which no (nil) tax is paid, and the taxable band, which is everything else in the estate.

The 'nil-rate band', which is everything up to the 'Inheritance Tax Threshold', is amended every financial year in the government's Budget. 

The current Inheritance Tax Threshold (2011-12) is £325,000. 

Example: Calculating Mrs A's Inheritance Tax (IHT)
Value of Mrs A's estate after deductions	£ 375,000
Nil-rate band	£ 325,000	(no tax is paid on this portion of Mrs A's estate)
Taxable band	£ 50,000	(tax is charged at 40% on this portion of Mrs A's estate)
Inheritance Tax  =  40% of £50,000  =	£ 20,000	(this is the total IHT bill that Mrs A's executors must pay from her estate)

Paying Inheritance Tax

Inheritance tax is due six months after the end of the month when the death occurred.  If the inheritance tax bill is not paid by this date then interest will be charged on outstanding bill.  However, inheritance tax on buildings and land can be paid in instalments over a ten year period, provided that they are not sold during this time.  If the building or land is sold, then the tax would be payable immediately after the sale.

Life Insurance Policies

Some people decide to set up life insurance policies, to make sure that when they die the money is available to pay off their inheritance tax.  By estimating the inheritance tax you are likely to be charged on your estate you can enter into an insurance scheme, which will ensure this is fully or partly covered when required.  Payments made into life insurance policies are exempt from inheritance tax.

More Information

www.hmrc.gov.uk                     HM Revenue and Customs

www.direct.gov.uk                    Direct Gov - the official government website for citizens

www.childtrustfund.gov.uk      Child Trust Funds