What is Inheritance Tax (IHT)?
Inheritance Tax, in brief, is a tax payable on someone’s deceased estate. This includes all of their possessions, money and property after any debts and funeral expenses have been deducted. Assets are defined as items such as funds in a bank, property/land, personal possessions, cars, shares, an insurance policy payout and jointly owned assets.
Although it regularly hits the headlines, only 4-5% of estates in the United Kingdom pay Inheritance Tax. If it is your wish to pass on your assets or valuables after you die, your beneficiaries could face a tax bill of up to 40% of the net estate value. IHT can be reduced or avoided in a number of ways, plus everyone has a tax free allowance limit. For those who plan ahead, it is possible to gift a certain amount of money tax-free, during a lifetime.
A Government guide to these IHT bands is available here: https://www.gov.uk/inheritance-tax
Inheritance Calculator tool (source – the Which Magazine) here:
Does my spouse pay IHT?
In most cases civil partners and married couples are allowed to pass their possessions and assets to each other tax free. The remaining partner is allowed to use any tax free allowances, providing the first spouse to die did not use up their full inheritance tax allowance by giving away a large amount of money in their will.
Does legal IHT avoidance exist?
Yes is the answer, and some gifts are tax exempt. These could include gifts between spouses, civil partners and a legacy to charities. Other gifts that are possibly tax free are known as potentially exempt transfers (PETs) and depend on when they were made. As a rule, as long as a gift is made more than seven years before the person’s death to an individual (not to a business or a trust) it will be tax free. If you do die within the seven years, the tax payable on the gift may be reduced depending on the date the gift was made.
If tax is due on gifts you made during the last seven years before your death, the recipient who received the gifts must pay the tax in most circumstances. If they can’t or will not pay, the amount owed then comes out of the estate. You’ll also need to include any gifts given before this period if the person who died continued to financially benefit from the gift. These are also known as ‘gifts with reservations of benefit’. One example is where an individual gives away their home, but continues to live in it until they die.
There are other ways to avoid inheritance tax, including placing life insurance policies into a trust, or having a deed of variation in your will. Trusts can also be a beneficial way to manage your IHT and keep control over what happens to your assets when you die.
There are also more choices such as property equity release and insurance policies, all avoiding inheritance tax legally.
Think about debts and liabilities that also reduce the value of the deceased’s chargeable estate to its net taxable value. Consider items such as all property holding costs: utility bills, mortgages, then there are credit card debts and funeral expenses and so on.
Please note: any costs incurred after death, such as solicitor’s and probate fees, can’t be deducted from the estate’s value for IHT purposes.
Who pays the IHT bill?
If there is a will, it’s usually the executor of the will who arranges to pay any IHT. If there isn’t a will, it’s the administrator of the estate who does this. IHT can be paid from funds within the estate, or from money raised from the sale of the assets.
However, most Inheritance Tax is paid through the Direct Payment Scheme (DPS). This means, if the person who died had money in a bank or building society account, the person dealing with the estate can request for any IHT due to be paid directly from that account through the DPS.
Your beneficiaries must pay any IHT due by the end of the sixth month after the person has died. If the tax is not paid within this timeframe, HMRC will start charging interest, use their calculator here:
Tips: An IHT reference number from HMRC is required and should be applied for at least three weeks before a tax payment is due. This can be done by post or online.
Once the tax and debts are paid, the executor or administrator can distribute what remains of the estate.
How do you value the estate?
To value an estate you will need to list all of the assets and work out their value at the date of the person’s death, and then deduct any debts and liabilities.
Tip: Remember to keep records of how these valuations were worked out. HMRC can ask to see records up to 20 years after Inheritance Tax (IHT) is paid.
The executors can choose to pay the tax on certain assets, such as property, by installments 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 installments with interest are paid at that point.
If an estate is likely to incur IHT, it’s a good idea for the executor to pay a portion of tax within the first six months of death, even if valuing the estate hasn’t been completed. This is called a payment on account. This will help the estate reduce the interest that it could be charged, if it takes a while to sell the assets.
If you have been appointed executor or administrator of the estate you will need to complete and send in an account of the estate within a year of the death, to avoid any monetary penalties.
A majority of 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 a policy is taken out. This means any money is paid out to your heirs and not to your legal estate. So any payout will not count towards your threshold, and won’t be subject to IHT. This would avoid a prolonged part of the probate process, so your benefactors will receive any payouts much faster.
A ‘whole life insurance policy’ is often used for this purpose, this remains in operation until the policyholder’s death, as long as there are regular payments being made.
Whole Life Insurance Policies – how do they work?
Simply, you set up a whole life insurance policy tailored to your circumstances and wishes. You must specify the policy is to be held in a trust. If you don’t, the money from the insurance payout is counted as part of the estate, and is 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 may need to have a clause written into the will to guide your policy trust trustees to use the funds in this way.