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What is inheritance tax in the UK?

The guide below explains the basic rules of inheritance tax and a few things to consider when you’re discussing your Will with a Will writer or solicitor.

Inheritance tax is just one factor to keep in mind when you’re making a Will. While tax shouldn’t be the be-all and end-all, it’s worthwhile optimising your Will to ensure your beneficiaries inherit as much as your hard-earned assets as possible. And not to lose it to tax when it could have been avoided.

If you book an appointment with Bristol Wills & Estate Planning, inheritance tax is one of the topics we’ll discuss during our first, free-of-charge meeting. Or search Google for will writers and will writing solicitors near me.

Three steps to making a Will

1

  BOOK AN APPOINTMENT

Pick a time and date to suit your diary.

2

  DISCUSS YOUR WILL

Tell us your aims and circumstances.

3

  SIGN YOUR WILL

It’s legal once signed and witnessed.

DISCLAIMER: To the best of our knowledge, the information below as accurate at the time of publication in 2024. The information below should be treated as a starting point for further discussion with a suitably qualified professional. It is a basic overview, not a comprehensive guide to every inheritance tax relief. Additional information on inheritance tax is available on Gov.uk and direct from HMRC. You should seek expert advice before taking any action in relation to inheritance tax planning. Bristol Wills & Estate Planning is not responsible for any action taken or losses incurred as a result of any errors or omissions on this page.

Will inheritance tax affect me?

Whether or not your estate will have to pay inheritance tax depends on a few different factors. They include:

  • The value of your estate at the time of your death
  • The thresholds and tax reliefs in force at the time of your death
  • If you are married, or in a civil partnership, and whether you have children
  • How your will is written
  • What you gave away in your lifetime.
  • The value of your estate at the time of your death

The value of your estate includes all of the assets worldwide. If you own any assets jointly, such as a property or bank account, the starting point would be to use half the value of these assets.

The figure that’s taken into consideration is the net estate. In other words, assets minus liabilities. So if you die with any loans, mortgages or other debts outstanding, these are deducted from the value of your assets.

Although you can have a rough idea in mind for the value of your estate, bear in mind that it will fluctuate all the time.

The value of your bank accounts will go up due to interest payments, and the value of property will increase. If you’re very lucky, you may even win a competition or the lottery (we can dream!). 

Probably the main factor that could affect whether or not you pay inheritance tax is increasing property prices. Between 2012 and 2022, the average house price in Britain increased by 71% according to Land Registry data.

Factors that act to reduce the size of your estate are gifts you give away, anything you buy, and less welcome drains on your finances such as care fees.

Thresholds and tax reliefs in force at the time of your death

There are two threshold figures to consider:

  1. The nil rate band
  2. The residence nil rate band

The following figures are correct as of 2024:

The nil rate band is an allowance available to anyone. The NRB is currently worth £325,000. That is, you can pass on up to £325,000 without paying inheritance tax. But you may be able to pass on more…

The residence nil rate band is available if you have a property (your main residence) and this passes to your “lineal descendants” when you die. Lineal descendants means children, grandchildren, stepchildren and adopted children. The RNRB is currently worth £175,000.

Two significant inheritance tax reliefs are:

  1. Agricultural Relief
  2. Business Relief 

Agricultural Relief is available if you leave land or pasture that is used to grow crops or to rear animals. Depending on the exact details, you may be entitled to 50% reduction or 100% reduction in inheritance tax for this asset.

If you pass on a business, or a share in a business, there is Business Relief. You may be entitled to a 50% or 100% in inheritance tax on property and buildings, unlisted shares, and machinery.

There are restrictions on this, including the time you must have owned the asset before it qualifies.

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Is the value of a property counted for inheritance tax?

Yes, property is included. If you own property jointly, your half would be taken into account. However, it may not be exactly 50% on the form.

As the notes for IHT400 say, “In the case of a house or land, the open market value of a share is likely to be less than a share calculated in this way, as a discount may be appropriate.” In the example they give, the discount was 10%.

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What is the rate of inheritance tax?

Inheritance tax is usually taxed at a rate of 40% on the excess amount above your allowances and exemptions.

So if your estate was £200,000 over and above your allowances and exemptions, the tax would be 40% of this, i.e. £80,000.

The rate of inheritance tax is slightly less if you give a certain portion of your estate to charity.

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Does my pension count for inheritance tax purposes?

Most pensions are held in trust. This means they are outside of your estate for inheritance tax purposes.

However, if the pension has “death benefits”, i.e. it pays a lump sum in the event of your death, it is important to complete a form that is called a nomination form or expression of wish form. The lump sum will then be paid to the people you list on the form free of inheritance tax.

If you don’t fill out this form, the pension may be paid into your estate and, if so, it would be subject to inheritance tax.

When you complete a nomination form, it’s worth thinking about the other assets your chosen beneficiary would inherit.

Once they receive your pension lump sum benefits, it could push their own estate over the allowance for inheritance tax. It’s worth keeping this in mind when you nominate beneficiaries of your pension.

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Does life insurance count for inheritance tax?

A life insurance policy will not count for inheritance tax if it is “written in trust”. Unfortunately, this is often not done by default! It’s worth asking your insurance provider if this is possible, and talking to a financial adviser to see if this is the best thing to do.

A policy that is not “written in trust” will pay into your estate when you die. And that means the payout will be counted for the inheritance tax calculation.

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What are the inheritance tax allowances?

There are two allowances available when someone dies, called “nil rate bands”. They are inheritance tax-free amounts and are called:

  • The nil rate band
  • The residence nil rate band

Nil rate band

The nil rate band (NRB) is the amount you can pass on without paying inheritance tax. This is true whether or not you make a will.

The nil rate band is £325,000 so, broadly speaking, you can pass on £325,000 without paying inheritance tax. Your allowance will not be the full £325,000 f you have made gifts in the 7 years before death.

Residence nil rate band

If you own a property (main residence) and you are passing it to “lineal descendants” (children and grandchildren), you have access to a second nil rate band called the residence nil rate band (RNRB). The residence nil rate band is worth up to £175,000.

You only qualify for this amount if your house, or the share of your house passing to children, is worth that much. If not, you qualify for a lesser amount.

However, for large estates, the residence nil rate band disappears. It reduces in value by £1 for every £2 that the estate exceeds £2 million.

It’s worth making a will to guarantee that your estate will qualify for the residence nil rate band. If you don’t make a will, your estate may pass to someone who doesn’t qualify.

In summary, a single person who owns a property and has children to pass it on to can pass on up to £500,000 without paying inheritance tax. The full allowance may not be available, depending on the gifts made during your lifetime.

If you’re married or in a civil partnership, unused allowances can be transferred and used by the surviving partner’s estate.

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Are married couples exempt from inheritance tax?

Yes. Anything passing to spouses or civil partners is exempt from inheritance tax. When the surviving spouse or civil partner dies, their estate will be subject to inheritance tax.

The estate of the surviving spouse/civil partner can use their nil rate bands, worth up to £500,000. They also have access to any unused nil rate bands from the first spouse.

This means that a married couple/civil partners can pass on up to £1m free of inheritance tax.

This is why many married couples/civil partners make “mirror wills”. This is where each person has a will that passes everything to each other.

That way, it doesn’t matter which person dies first, there is no inheritance tax to pay.

Mirror wills don’t have to be simple wills to qualify for this exemption. Each will could include a life interest for the spouse/civil partner.

During lifetime, any transfers of any amount between spouses or civil partners are exempt for inheritance tax.

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What are the lifetime inheritance tax allowances?

One way of getting your estate value below your available thresholds is to give away money and potentially other assets, if you can afford it.

There are two important factors:

  1. You must survive 7 years after making the gift for it to be free of inheritance tax (the 7-year rule)
  2. You cannot continue to enjoy the benefit of the money or asset.

Sometimes you hear of people who “give away” their house to children in an attempt to avoid inheritance tax. However, this would not be exempt from inheritance tax if you continue to live in it unless you pay a market rent, regularly reviewed. Otherwise, you would still be receiving the benefit.

If you make a gift and then die more than three years but less than 7 years after making it, there is a reduced rate of inheritance tax on that gift. It is known as “taper relief” and is calculated on a sliding scale.

You can make other gifts in your lifetime that are completely exempt and are not subject to the 7-year rule:

  • Annual exemption (up to £3,000 per year)
  • Small gifts (£250 per person)
  • Gifts out of regular income, including birthdays and Christmas presents (any amount)
  • Gifts to someone getting married/civil partnership:
    • Gift to a child (£5,000)
    • Gift to a child or great-grandchild (£2,500)
    • Gift to any other person (£1,000)

The wedding/civil partnership allowance can be combined with any other allowance except the small gift allowance.

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What is the inheritance tax 7-year rule?

It is the rule that gifts you make in your lifetime are exempt from inheritance tax if you live for 7 years after making the gift.

In the tax rules, such a gift is called a “potentially exempt transfer” (PET). You can think of a PET as potentially exempt from inheritance tax if you live long enough.

Gifts can be made directly to an individual, or into trust. Gifts into trust are subject to their own tax rules, and there may be an immediate charge to inheritance tax if it’s over a certain amount.

It’s worth noting that there are a few exceptions – some transfers are not classed as PETs. You should check with your financial adviser or look at the HMRC website to check what these are.

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Are gifts into trust subject to inheritance tax?

Yes, but there is a different way of charging tax on them.

If you put assets into a trust, whether it’s money or property, it is called a chargeable lifetime transfer.

If you gift more than the nil rate band (currently £325,000) in a 7-year period into discretionary trusts, you are charged 20% tax on the excess amount.

There may also be regular (“periodic”) charges and exit charges as well, so it’s essential to take expert advice.

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What records do I need to keep of gifts I make?

When you make a gift in your lifetime, it could be exempt from inheritance tax after 7 years. Most lifetime transfers will qualify but there are a few exceptions.

To make sure they qualify, the person filling out the inheritance tax form will need to provide information about the gift. So to help reduce their workload, it’s worthwhile recording:

  • Date gift made
  • Value at date gifted
  • Name and relationship to the recipient
  • Description of the asset gifted
  • Exemptions of reliefs (e.g. charity relief, business relief, agricultural relief)
  • Value of gift minus exemption

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Are gifts to charities exempt from inheritance tax?

Yes. As outlined in the Inheritance Tax Act 1984, gifts to charities in wills are exempt from inheritance tax.

For wills made in England and Wales, a charity is certain to qualify for this exemption if it is listed in the charity register of England and Wales.

If you leave 10% or more of your estate to charity, the rate of inheritance tax becomes 36% instead of 40%.

This means that if you think your estate is liable for inheritance tax, you could potentially leave a bigger gift to charity and your loved ones would end up with the same amount because the estate would pay less tax.

All gifts to charity during your lifetime are exempt.

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Are gifts to any other organisations exempt from inheritance tax?

Apart from charities, the Inheritance Tax Act 1984 outlines how gifts to certain other organisations are exempt from inheritance tax.

They are gifts:

  • To registered clubs (e.g. community amateur sports clubs)
  • To political parties
  • To registered housing associations
  • For national purposes

To be an exempt gift, a political party must either have two members elected to the House of Commons or just one elected member and more than 150,000 votes for all candidates.

A gift for national purposes means to a museum, university or one of the other organisations listed in the Act.

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    Are assets abroad counted if I die in the UK?

    Yes, if you die domiciled in the UK, then all of your assets worldwide count for inheritance tax.

    But if you own an asset in another country, such as a property, that country may also levy a death tax on it.

    However, your estate may not have to pay double the amount of tax on the same asset. The UK has double-taxation treaties with a few countries so it may be possible to avoid or reclaim the extra tax.

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      What legal obligations do the executors of a will have to pay inheritance tax?

      Inheritance tax is paid from the estate of the deceased. So as the person administering the estate, the executor is responsible for paying it.

      If the person left no will, the administrator of the estate pays the inheritance tax.

      If there are insufficient funds available to pay the outstanding bill, assets may have to be sold.

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        Can the right kind of Will help me avoid inheritance tax?

        Avoid is the wrong word to use here. But as a starting point, the right Will can minimuse inheritance tax by ensuring you use all your exemptions in the most efficience manner.

        For example, a Will can ensure that you make use of your spousal exemption if you are married or in a civil partnership.

        Likewise, a correct Will ensures that a main residence, or the proceeds of sale, passes to “lineal descendants”, guaranteeing that the residence nil rate band (RNRB) inheritance tax allowance is available.

        Likewise, a will can make full use of reliefs like agricultural relief or business relief by utilising trusts. This would avoid a spouse inheriting shares in a business, for example, and then only having their standard nil rate bands available.

        Finally, gifts to charity are exempt. If you give a sufficient amount to charity, your inheritance tax rate is reduced.

        The right will ensures that even if you give more to charity, beneficiaries inherit the same amount because the tax rate would be the same.

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          Will inheritance tax be scrapped?

          Prior to the 2023 Autumn Statement, there was much speculation in the media that inheritance tax might be scrapped or dramatically reduced.

          In the end, the rules remained unchanged. A future government could make a change… or not… It’s impossible to forecast.

          The last meaningful change to the rules came in 2017 when a new allowance, the Residence Nil Rate Band, as introduced.

          The last change to the main threshold, the Nil Rate Band, was in 2009 when it was increased to its current level of £325,000.

          So what should you do?

          Inheritance tax is subject to change like any other tax. All you can do is plan based on today’s rules and adjust your will and planning if things change.

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            How to use this information

            This article represents our understanding of the law and tax rules at the time it was published (2024). It provides general information and is intended as a starting point for further research and conversations. Please seek competent professional advice before taking any action in relation to Wills and estate planning. Bristol Wills & Estate Planning Ltd is not liable for any errors or omissions on this page or for any actions taken as a result of reading this information.

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