A guide to inheritance tax

Inheritance tax concept image with wooden family and house

Inheritance tax (also known as IHT) is something that some estates in the UK have to pay if they're deemed to be “large” enough.

However, it’s still something that you should be aware of and it’s good to know more about inheritance tax in 2021, especially when it comes to preparing your will.

In our guide to inheritance tax planning, we explain all about home inheritance tax, the IHT threshold and allowance, as well as a brief insight into what is included in the Inheritance Tax Act 1984 and how it affects IHT today.   

What is inheritance tax and how does it work?

Inheritance tax is a form of death tax that must be placed on the estate of someone who has died. This includes all their property, money, possessions, life insurance and more. Even if there is no inheritance tax to pay, it must still be reported to HMRC so that everything is held accountable. 

How much is inheritance tax?

The nil rate band is also known as the inheritance tax threshold and at the current rate, it is £325,000. This means if your estate is valued at less than the nil rate band, your loved ones won’t have to pay inheritance tax upon your death.

However, if your estate is worth more than the nil-rate band, you will be liable to pay inheritance tax at a rate of 40% of anything remaining over the threshold.

In order to see how much the estate is worth, you will need to work out the value of all the assets at the date of death, such as money they have in the bank, any property or land that they own, plus items such as jewellery and cars, and any other assets. You will also have to deduct any debts and liabilities such as bills, credit card debts and mortgages.

Once you’ve done this, you should have a pretty accurate estimate of the value of the estate. However, it can be very complicated to work everything out, so you might want to consider seeking the help of a financial expert who can provide solid advice on how to calculate everything properly.

Who pays inheritance tax?

Who pays the inheritance tax depends on different circumstances.

For example, if the person who has died created a will, then it’s usually left to the executor of the will to arrange the payment of inheritance tax. However, if there isn’t a will available, then it’s left to the administrator of the estate to pay it.

You might like: End of life planning: A checklist

When do you have to pay inheritance tax?

Inheritance tax must be paid no later than the end of the sixth month after the person’s death. After this time, if the tax still has not been paid, HMRC will start charging interest on it.

Inheritance tax gifts

In some cases, there are instances where some gifts and property are exempt from IHT, such as wedding gifts or charitable donations. In these instances, you won’t have to pay inheritance tax on these things.

If you decide to give your estate and assets away but then you survive for more than seven years after doing so (also known as the 7-year rule), then all gifts are considered to be free and you won’t have to pay inheritance tax.

However, if you die before those seven years, then the gift will still be counted towards the estate and therefore subject to inheritance tax.

Read more: What to consider when leaving gifts in your will

Probate and inheritance tax

With regards to probate and inheritance tax, if the person has decided to leave their estate in a trust, you should be able to avoid the lengthy probate process, which also means you’ll avoid having to pay any inheritance tax fees as well.

Do I have to pay inheritance tax on my parents’ house?

If your parents leave their house to you in their will and it sits under the inheritance tax threshold of £325,000 or £650,000 if they are married, then there is usually no inheritance tax to pay.

However, if your parents’ estate is valued higher than the threshold amount, you will have to pay 40% of anything above the threshold.

Inheritance tax forms (where to get them)

You can find inheritance tax forms on the UK Government website, where you can download them and use as needed.

Other taxes your heirs may have to pay on their inheritance

While you would think that having to pay inheritance tax would be enough, there are also some other types of taxes that you might have to pay as an heir to someone who has died.

Capital gains tax is one example of this; if you sell your inheritance such as a property for more than it was worth when the person died, then you will have to pay capital gains tax.

As an heir, you might also have to pay income tax on your inheritance if it produces a regular income for you (such as dividends or rent from a property that you inherited). 

How to avoid inheritance tax

You can “avoid” inheritance tax by doing one of the following:

  • If the value of your estate is lower than the nil rate band.
  • If you leave everything in your estate above the threshold to your partner or spouse.
  • If you leave everything in your estate above the threshold to an exempt beneficiary such as a charity.
  • If you decide to give away your home and estate to family members such as children or grandchildren, your threshold can sometimes increase to £500,000.
  • If you make a will and state exactly how you want your assets to be distributed.
  • If you give your assets away and take advantage of the ‘7-year rule’.
  • If you put your assets into a trust, they won’t form part of your estate and won’t be subject to inheritance tax.
  • If you regularly give gifts away up to the value of £3,000 each year.
  • If you pay into a pension rather than a savings account.

Find out more on reputable websites like GOV.UK, or read our related guides below for further useful information.

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