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How is inheritance taxed?

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Inheritance tax is undoubtedly one of the most unpopular taxes in the UK, yet for the vast majority of people there is nothing to pay. So what exactly is Inheritance Tax? Here is what you need to know.

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Inheritance tax (IHT), or death duty as it’s also known, is due on some estates after someone passes away. However, only a few people pay it because the IHT allowance means that for most there's nothing to pay. For those that do face an IHT bill, the fees can be significant. Here is how it works and how much is due.

What is inheritance tax?

Inheritance tax is due when a person dies and leaves property or possessions behind.

It is applicable on the total value of their estate - that is the sum total of all their savings and investments combined with the current value of their property and possessions.

The first £325,000 of any estate is exempt from inheritance tax. This is called the nil rate band and means that most people pay little or no inheritance tax when they die.

If you leave your home to your children or grandchildren, you can also take advantage of an additional £175,000 tax allowance called the residence nil-rate band. If this applies your tax exemption is increased to £500,000. 

How much is inheritance tax?

While inheritance tax is not payable on the first £325,000 of an estate, above this threshold the rate is set at 40%.

Inheritance tax is only applied to anything above the £325,000 or £500,000 threshold, not on the estate's full value. This means if you inherit a total estate worth £425,000, for example, inheritance tax will only be applied to £100,000 (as opposed to the full amount). Consequently, you would need to pay £40,000 of inheritance tax.

Are there any exemptions?

As well as the first £325,000 of an estate being exempt from inheritance tax, there are a series of other exemptions that can protect an estate from inheritance tax.

These include, but are not limited to:

  • Anything left to a husband, wife, or civil partner as long as they reside in the UK

  • Gifts to registered charities

  • Gifts the deceased made over 7 years before their death

  • Small gifts of up to £250

  • Wedding or civil partnership gifts

  • The value of any farms, businesses, or commercial properties

The value of these exemptions are excluded from the final value of the estate. For example, if an estate is worth £375,000 but gifts of £50,000 are left to charity then no inheritance tax would be payable at all.

Similarly, a person can leave their entire estate to their spouse, and no inheritance tax would be due on their passing. The £325,000 inheritance tax exemption would be passed to the spouse meaning they were able to leave up to £650,000 behind free from inheritance tax.

Tax rules apply and may be subject to change.

gov.uk inheritance tax reliefs list

How can you work out how much an estate is worth?

If you are unsure how much your estate is worth then you will need to work out its total value, including all the different elements such as shares, property, investments and businesses.

You may also need to do this if you have recently inherited and are responsible for paying inheritance tax. Visit the GOV.UK website for more guidance on calculating the total value of an estate to see if inheritance tax is due.

gov.uk website

Do you have to pay in a lump sum?

In most cases, inheritance tax is paid as a lump sum directly from the value of the deceased estate.

In certain circumstances, inheritance tax can be paid in instalments, usually where an asset included in the estate, such as a property or shares need to be sold.

Find out how to pay an inheritance tax bill on the gov.uk website.

gov.uk inheritance tax bill information

How can I avoid inheritance tax?

If you are worried about how much inheritance tax will be taken from your estate after you pass away then you should look at ways to reduce your liability.

There are several ways that you can legally reduce your inheritance tax bill so your beneficiaries do not lose a big chunk of their inheritance to the taxman. Putting money into a trust, life insurance policy, or gifting it can all be ways to reduce an IHT bill if done correctly.

Taking advantage of the various exemptions outlined above is the best way to do this, although you may want to seek financial advice before making any decisions.

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