A Beginner’s Guide to Inheritance Tax – Inheritance Tax FAQ

A Beginner’s Guide to Inheritance Tax – Inheritance Tax FAQ

The end of life isn’t something anyone wants to spend much time thinking about, but a lack of preparation can leave your loved ones with a hefty Inheritance Tax bill. Inheritance Tax, intended to redistribute the wealth of the super rich, has become something more and more of us have to deal with as a result of inflation and rising property prices. So, it’s important to get your head around the technicalities before it’s too late!

Hansford Bell are a team of financial life planners based in Tavistock. We’re committed to our clients, and love nothing more than helping people achieve their aspirations – financial and otherwise! With our team of financial experts at your side, you can mitigate your estate’s tax liability, and maximise the wealth you can pass on to your loved ones.

In this article, we answer some of the most commonly asked questions about inheritance tax.

What is Inheritance Tax?

Inheritance tax is a tax on the estate of someone who has died. The estate is essentially everything that person owned during their lifetime, including property, investments, insurance, and assets like cars, jewellery, or furniture. Non-exempt gifts that have been made in the past seven years are also part of the total.

How Much is Inheritance Tax?

Inheritance Tax is only paid if the value of the estate is above £325,000. But, with property prices rising and the nil rate band frozen at this figure until 2026 at least, more and more people are finding themselves liable.

Tax is charged on the amount of the estate above the nil rate band, currently at a rate of 40%. Simple, right? To confuse matters, there are a number of exemptions, complications, and other things to be aware of.

For example, if you leave 10% of the net value to a charity, your rate of tax will be reduced to 36%. You also have a number of tax free allowances when it comes to gifting money and assets, which we will expand upon later.

How is Inheritance Tax Calculated?

To help clear things up for you, let’s see the tax calculation in action. Imagine your estate is worth £330,000. That means, you’re £5,000 above the nil rate band. Assuming you don’t give your main residence to a direct descendant, and you don’t have a spouse (more on these exemptions below!), the tax on your estate will be 40% of £5,000. So, at current rates, £2,000 is the amount your estate would be charged.

What is Exempt from Inheritance Tax?

Your estate will be exempt from Inheritance Tax if:

  • You leave everything above the threshold to a spouse or civil partner who lives in the UK.
  • You leave everything above the threshold to a charity or political party.

Also, if you give your main residence to your direct descendants (children or grandchildren), your nil rate band can increase by £175,000 to £500,000. However, this only applies if your estate is worth less than £2 million. If the value exceeds this, the main residence allowance will decrease by £1 for every £2 above £2 million that the estate is worth.

Another thing to be aware of is that your Inheritance Tax threshold can increase by the percentage of the allowance a partner didn’t use. So, together, a couple can leave a £1 million estate to their children without being taxed.

Read next: Retirement Planning Strategies for People in Their 50s

When Do You Pay Inheritance Tax?

Inheritance Tax must be paid within 6 months of the death, otherwise HMRC will start charging interest. It can take a long time to fully value an estate, but it’s okay to begin making payments before the final figure has been established. Inheritance Tax forms must be sent in to HMRC within a year.

Normally it is down to the executor of the estate to take care of the payment, and it will be taken out of the estate before distribution. Payments need to begin before beneficiaries are granted probate and have access to the money.

How Do I Prepare for Inheritance Tax?

There are various things you can do to prepare for Inheritance Tax if you know you will be leaving an estate above the nil rate band. Work out the value of your estate and write a will – this should go without saying but we thought we’d remind you anyway! You might also want to consider using a trust. This way, you can leave someone a large sum of money and it won’t be included in the taxable estate because technically it belongs to the beneficiary of the trust now, not you.

Another great step is to take out a life insurance policy, which can be done in trust for no extra cost. This way, your loved ones can receive compensation before being granted probate on the estate, which will help them pay the tax bill.

Find out more about Life & Health Insurance >

How to Cut Your Inheritance Tax Bill.

Aside from the steps mentioned above, there are some great ways to legally mitigate your tax liability by reducing the value of your estate through gifts. Gifts given within seven years of your death are included in the value of your estate, however, there are a number of exemptions:

  • You can give away £3,000 each tax year. This is called your annual exemption. It’s important to note that this doesn’t mean per gift; rather, it is your entire allowance that tax year.
  • Gifts to charities, political parties, and other exempt organisations don’t get taxed.
  • Alongside your annual exemption, everyone has a ‘small gifts’ allowance of £250 each tax year to cover things like Christmas and birthday money.
  • Wedding gifts are not charged tax below a certain amount. Parents can give their offspring £5,000 tax free, grandparents can give £2,500, and anyone else can give £1,000.
  • If you have extra taxed income that you can give away without it affecting your quality of life, it is called surplus. You can do various things with this money, such as pay it into a child’s savings account, or use it for the maintenance of relatives who depend on you. You must keep records of this and be able to prove the money is not coming from your savings, as everything has to be reported to HMRC in the event of your death.

For gifts not included in these exemptions that are given within seven years, there is also something called ‘taper relief’. This term basically means your estate will be charged tax on a sliding scale depending on when the gifts were given. So, if you give a large gift three to seven years before your death, the rate of tax will be slightly reduced.

Protect Your Estate with South West Financial Life Planners.

Tax is a fact, but that fact can be made smaller with the right plan in place.

Working with a team of financial professionals can help you get to grips with all the ins and outs of Inheritance Tax before it’s too late to take the necessary steps. We all want to pass on as much as we can to our loved ones to ensure they flourish even without us there to watch.

Talk to our team today and we’ll help you get started.

*Note – The Financial Conduct Authority do not regulate all forms of tax and trust planning.