What are the rules of Inheritance Tax?

Inheritance Tax or IHT as it is also known, is a tax on the estate of someone who has passed which includes all of their property, possessions and money. Only a small percentage of estates are actually large enough to incur inheritance tax although this is increasing. It can be a complex subject to understand, however, in this blog we will explain the best we can and hopefully, in turn, help you with whatever query you may have.

How much is Inheritance Tax?​

You shouldn’t have to pay tax if any of the following apply:

  • The value of your estate is below the Nil Rate Band (NRB) of £325,000.
  • You leave everything above the threshold to your spouse or civil partner.
  • You leave everything above the threshold to an exempt beneficiary, such as a charity.

     

If however, the value of your estate is above the Nil Rate Band (NRB) then the part of your estate above the threshold may be liable for tax at the rate of 40%.

For example, if your estate is worth £525,000 and your IHT threshold is £325,000, the tax charged will be on £200,000 (£525,000 – £325,000). The tax would be £80,000 (40% of £200,000).

The NRB is fixed at £325,000 until 2021, but your NRB could be increased depending on if you’re a surviving spouse or civil partner. Spouses and civil partners can transfer any unused NRB when the first person dies to the survivor. 

This means that your NRB can be doubled if the entire NRB was unused. This extra transferable element is called the Transferable Nil Rate Band (TNRB).

The Residence Nil Rate Band (RNRB) has been introduced more recently.

The NRB and the TNRB are used in conjunction with the RNRB where it applies. You have to leave your home or a portion of it to a direct descendant, such as  children, grandchildren etc to be eligible. This covers step- children, adopted children and foster children, but not nieces, nephews and siblings.

The below table shows the rises of the RNRB and the projected combined allowance:

Tax Year   

Resident Nil Rate Band (£)

Nil rate band (£)

Combined allowances (£)

2018/19

125,000

325,000

450,000

2019/20

150,000

325,000

475,000

2020/21

175,000

325,000

500,000

If the total value of your property is greater than £2million, there is a tapered withdrawal of the residential allowance. The residential allowance provides you with an extra allowance to be used to reduce any IHT liability against your estate if the terms and conditions are met for 2019/20. The RNRB allowance is £150,000, but it will rise to £175,000 in 2020/2021 and increase in line with the Consumer Price Index thereafter.

How to value the estate?

To value an estate you will need to:

  • List out all the assets and work out their value at the date of death.
  • Deduct any debts and liabilities.

Remember to keep records of how you’ve done this, such as the appraisal of the estate agent. HMRC may request documents from up to 20 years after the payment of Inheritance Tax (IHT). 

Assets include items such as cash / bank holdings, property and land, jewellery, cars, shares, an insurance policy pay-out and jointly owned assets. Gifts, such as money or other property, must also be considered if they were given away in the seven years prior to the person’s death. If the person who died continues to benefit from the gift, you will also need to include any gifts given before this time. These are also referred to a Gift with Reservation.  For example, gifting the family home but then continuing to live in it.

Liabilities and debts lower the value of the chargeable estate of the deceased. Think of things like household bills, deposits, loans from credit cards and funeral expenses in particular. However, any costs incurred after the death, such as solicitor and probate fees, can’t be deducted from the estate’s value for IHT purposes.

Who pays Inheritance Tax?

If there is a Will in place, it’s usually the executor of the Will who arranges to pay the Inheritance Tax (IHT). The administrator of the estate does this if there isn’t a will. IHT can be paid from property funds or money raised from the sale of the assets but if there is not a Will in place, the IHT will need to be paid before the assets of the estate can be released.

Most IHT, however, is paid through the Direct Payment Scheme (DPS) that’s currently in place. It assumes that if the person who died has funds in a bank or a company account, the person dealing with the estate may apply for all or some of the IHT to be paid directly through the DPS.

The person who died sometimes leaves money to pay IHT. This is normally arranged through a life insurance policy that remains in effect until the death of the policyholder, as long as the premiums are paid. Payments from a life insurance policy may be subject to IHT. This can be avoided if the Life Assurance plan is written in Trust, and this asset then falls outside of the estate and is not subject to Probate.

Once the tax and liabilities are settled, what remains of the estate can be divided by the executor or manager.

When do you have to pay Inheritance Tax?

Inheritance Tax (IHT) must be paid after the death of the person by the end of the sixth month. HMRC will start charging interest if the tax hasn’t been paid within this time frame. The executors may choose to pay the tax on certain assets, such as land, by instalments over 10 years, but interest will still be paid on the accrued amount of tax.

If the property/ asset is sold before all the IHT is charged, the executors must ensure that all instalments (and interest) are collected at that stage. If your estate is likely to incur IHT, it is a good idea for your executor to pay some of the tax within the first six months of the death, even if they have not finished valuing the assets. This is called payment on account.

This will allow the estate to reduce the interest it might be paying if it takes longer to sell the property / assets and pay off the debts and taxes. If the executor or Trustee pays the tax from their own bank, they may claim it back from the estate.

HMRC must refund the estate once probate has been granted if it has overpaid IHT. Probate is the right to deal with the land, money and possessions of the deceased person. This is called confirmation in Scotland.

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 a penalty.

Reducing the amount of tax to pay

It can be complicated when trying to reduce how much IHT is due on the estate. 

In short, you can actually reduce how much tax is paid by doing the following:

  • Leaving a legacy to charity.
  • Putting your assets into a trust for your heirs.
  • Leaving your estate to your spouse or civil partner.
  • Paying into a pension instead of a savings account.
  • Regularly giving away up to £3,000 a year in gifts.

What can we do?

Here at Smith Eliot, we can offer a wide range of services to help you better understand and be prepared when it comes to dealing with your inheritance tax.

You will need to ensure that your Will is up to date, well- structured and written in a correct way. Take your time whilst considering transferring assets, especially when using lifetime gifts. 

Look at creating a more tax-efficient fund, this allows the beneficiaries of your estate to meet the tax liability without eroding your family wealth.

We can look after all of this for you, as well as talk you through everything you need to know. We understand that this process can be very taxing and hard to monitor, so we take the hard parts and do them for you. 

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

Will writing involves the referral to a service that is separate and distinct to those offered by St. James’s Place. Wills and Trusts are not regulated by the Financial Conduct Authority.

If you are interested in any of our services, please feel free to contact us on any of the points discussed in this blog or if you have any other queries don’t hesitate to ask.