Understanding Inheritance Tax and its potential impact

Inheritance Tax (IHT) is a tax which is applied to your estate (property, money and possessions) upon your death. It brought in nearly £6 billion into HMRC coffers in 2021/22 - up over £500 million on the previous year.[1]  

It is worth getting an understanding of roughly how much IHT would be due on your death, and whether you would potentially benefit from some IHT planning advice.

When does IHT apply?

IHT is only charged on the part of your estate that is above the threshold of £325,000, at which point the standard IHT rate is charged at 40% – so the first £325,000, or Nil Rate Band, is free of tax.

There’s normally no IHT to pay if either:

• The value of your estate is below the £325,000 threshold
• You leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club, if they fulfil certain criteria.

Understanding reliefs and exemptions

Everyone has a Nil Rate Band, but whether you have a full Nil Rate Band will depend on whether you have made any gifts in the seven years before dying – either of cash or assets of value.

Depending on when you gave the gift, ‘taper relief’ might mean the Inheritance Tax charged on the gift is less than 40%.

People you give gifts to might have to pay Inheritance Tax on it, but only if you give away more than £325,000 and die within 7 years.

There is no IHT payable on any part of your estate that you leave either to a charity, spouse/civil partner or political party.

The estate can pay Inheritance Tax at a reduced rate of 36% on some assets if you leave 10% or more of the ‘net value’ to charity in your will. (The net value is the estate’s total value minus any debts.)

Your estate will also be able to claim any unused Nil Rate Band and Residence Nil Rate Band of your spouse or civil partner who died before you, so potentially the first £1,000,000 of a married couple’s combined estate, for example, will be free of IHT.

What counts as your ‘estate’

For IHT purposes, the value of your estate includes your savings, possessions including property, payment funds (certain payments from payment funds may be subject to Inheritance Tax) and, subject to some exemptions, the value of any money or property you gave away during the seven years prior to death.

It also includes assets you own with someone else. For example, your home, owned with your spouse or partner, or a joint bank account.

Although ownership of most jointly-owned assets automatically may pass to the surviving joint owner on death, the value of your “share” would still be added to the assets in your sole name, to calculate IHT.

With this in mind, it is worth checking how you own your home.

If you own a property, you leave it to your children and/or grandchildren, and your estate does not exceed £2,000,000, then there is potentially an additional “Residence” Nil Rate Band of £175,000 that can be claimed on top of the Nil Rate Band of £325,000, “free” of IHT.

This makes a total of £500,000 (subject to any gifts you made within the last seven years before you die) “tax free” before the balance is taxed at 40%.

Of course, everyone is different, and there are other factors to consider when working out how much IHT would be due, but these are just some of the basics.

It is advisable to think about IHT planning during your lifetime, as there are various things you can do to reduce the value of your estate and thereby reduce the potential IHT.

This can include everything from making use of your Annual Allowance or gifting any excess income to making sure that any life cover or pension “pot” is outside of your estate for IHT purposes.

Certainly, the financial benefit in inheritance tax savings from expert IHT advice will, almost certainly, outweigh the cost.

Photo by Annie Spratt on Unsplash