Inheritance Tax (IHT) Explained
What is Inheritance Tax?
Inheritance Tax, or IHT as it is also known, is the tax that is charged on the value of a deceased person’s Estate.
Each year around 25,000 deaths result in an Inheritance Tax bill – a figure that continues to rise.
How much tax do you pay on inheritance?
Inheritance Tax is calculated at 40% of the value of the estate that falls above the nil rate band, which is currently set at £325,000 for a single person. In the 2019/2020 tax year the average Inheritance Tax bill was around £200,000. An IHT bill needs to be settled before the estate can be released to the Beneficiaries of the Will.
What is the IHT Threshold?
A typical IHT scenario example: If an estate is worth £525,000 the tax charged will be on £200,000 (£525,000 less the £325,000 allowance for a single person). The Inheritance Tax therefore that would need to be paid would be 40% of £200,000 which is £80,000.
Do Beneficiaries of a Will have to pay Inheritance Tax?
Inheritance Tax needs to be paid before any Estate can be distributed, but that doesn’t mean everyone due to receive an inheritance is liable to pay IHT.
If there is a Will, the Executor of the Will is liable to settle the Inheritance Tax bill. However, if a Will hasn’t been left then the responsibility will fall to the administrator (Personal Representative) of the Estate. Only once the Inheritance Tax and any debts have been settled the Executor or administrator can distribute the estate to Beneficiaries.
This is because the Executor or administrator needs to obtain a Grant of Probate in order to dispose of the estate assets, and they are not able to get a Grant of Probate until the IHT has been paid to HMRC.
What is Probate?
Probate is the right to deal with the deceased person’s property, money and possessions. In Scotland this is called Confirmation.
When do you need to pay Inheritance Tax?
Inheritance Tax has to be paid before Probate can be granted, and within six months of the person’s death. Once this deadline has passed, HMRC will start charging interest on the Inheritance Tax.
The longer it takes for an IHT bill to be paid the more interest is added. Currently the interest rate is set at 2.6% for late payments. HMRC will refund the estate if it has overpaid IHT once probate has been granted.
Do I need to pay Inheritance Tax?
You need to pay Inheritance Tax if the estate that has been left is more valuable than the £325,000 threshold for a single person.
However, there are some Inheritance Tax exceptions:
- The value of the estate is below the £325,000 threshold
- Anything above the threshold is left to a spouse or civil partner
- Anything above the threshold is left to an exempt Beneficiary, such as a charity or community amateur sports club
There are also other very specific exemptions, such as the Estates of people who die while in active service, like those in the armed forces, police and paramedics, who are exempt. This exemption also applies if a person is injured on active service and has their death hastened by the injury. This applies even if they have left active service at the time of their death.
Does my spouse need to pay Inheritance Tax?
The Inheritance Tax exemption rules for couples can be confusing. Married or registered civil partners do not have to pay any Inheritance Tax on any asset left by their spouse.
When the second partner dies, the estate qualifies for a married couple’s transferable allowance, which is the sum of two single people’s allowance, or £650,000. This extra transferable element is known as Transferable Nil Rate Band (TNRB).
Do cohabiting couples have to pay Inheritance Tax?
There is no specific IHT allowance or exception for cohabiting couples. If you’re not married, but own assets jointly, the situation can get complicated, especially where property is concerned.
If you are joint tenants – meaning you both own all the property – and your partner left you everything in their Will, if the assets (including the property) exceed the Inheritance Tax threshold of £325,000 you will have to pay a 40% tax bill on any estate value above that.
After your partner’s death the property would be owned by you in its entirety. If there was no Will, the property can still be transferred to you through the ‘right of survivorship’ and the same Inheritance Tax rules would apply. However, without a Will any family members of your partner would have a right to claim their share of other assets left.
What do you pay Inheritance Tax on?
IHT is paid on the total value of the estate left by the deceased which includes bank accounts, pensions, properties, jewellery, vehicles, shares, jointly owned assets and pay-outs from insurance policies.
However, it is the net value of the estate after any debts have been accounted for such as debts/mortgages, funeral expenses, other taxes, or other expenses incurred in managing the estate.
Do you pay Inheritance Tax on gifted money?
You do not pay tax on cash gifts, but there are strict rules. Besides, you may pay income tax on any income that arises from the gift, such as bank interest.
While someone is still alive, they can gift as much as they want, to anyone they want, in the form of ‘potentially exempt transfers’ (PETs). However, if that person passes away, those gifts (or PETs) can then be included in the estate of the deceased person.
Under the current rules if the gift is given before death, and the donor lives for more than 7 years after any assets were given, it will be IHT exempt. However, if the donor dies sooner Inheritance Tax will be charged on the gifts at various levels. If the giver dies:
- Within 3 years of giving the gift – 40%
- Within 3 to 4 years – 32%
- Within 4 to 5 years – 24%
- Within 5 to 6 years – 16%
- Within 6 to 7 years – 8%
- After more than 7 years – 0%
Gifts to your spouse or civil partner, charities and gifts up to £250 a year to as many people as the donor liked are IHT exempt, as are payments to help an elderly relative or minor with living costs.
Are gifts to spouses exempt from Inheritance Tax?
When a couple marry, people are also allowed to give the following wedding gifts without the money being included in the giver’s estate:
- Parents can gift cash up to £5,000
- Grandparents can gift up to £2,500 each
- Anyone else can gift up to £1,000
Do you pay Inheritance Tax on a house?
Depending on your relation with the deceased, you may not need to pay tax when you inherit a house.
If the house that was the primary residence of the deceased has been left to direct descendants, for example children or grandchildren of the deceased, then they can access a further tax-free allowance of up to £175,000 per person which is in addition to the £325,000 threshold for a single person.
This is called the ‘Residence Nil Rate Band’ (RNRB) and it can be passed on to children and grandchildren only. This means that Inheritance Tax may not be due on the first £500,000 of the estate per individual.
For couples, where the estate passes to the surviving spouse before passing to the descendants, and the main property is left to direct descendants, it is possible to have up to £1m in tax-free allowance (£325,000 per person nil rate band and £175,000 per person RNRB).
However, the £175,000 RNRB allowance only applies if the estate that’s been left is worth less than £2m. On estates that are worth in excess of £2m the RNRB allowance will decrease by £1 for every £2 above £2m that the deceased estate is worth. If the property has been left to Beneficiaries who aren’t direct descendants of the deceased, then an IHT bill of 40% will be liable for anything over the £325,000 single person allowance.
How do I pay Inheritance Tax?
An Executor or administrator can pay Inheritance Tax from their own bank account using the IHT reference number online or by telephone banking, CHAPS or BACS and/or at your bank. They can also make payment from any joint accounts held with the deceased. Any amount paid can be later reclaimed from the deceased’s estate once probate has been granted.
What happens if you can’t afford Inheritance Tax?
Unfortunately, this is a common occurrence and is a classic ‘chicken and egg’ situation – where the Executor or administrator needs the Grant of Probate in order to start disposing of the estate assets in order to generate money to settle the IHT bill but can’t get the Grant of Probate until they have paid the IHT.
Each year an estimated 2,000 families are unable to afford the average up front IHT bill of around £200,000. Tower Street Finance has therefore designed a unique Inheritance Tax Loan product to help you when you can’t afford Inheritance Tax.
How to get a loan to pay Inheritance Tax?
Regulated by the Financial Conduct Authority, the Tower Street Finance IHT Loan is paid directly to HMRC, allowing families to start the legal process and receive their inheritance.
The IHT Loan is risk free: there are no credit checks, no charge over property, no personal liability, or monthly repayments. The loan is repaid from the estate funds once it is ready to distribute. There is a 2% origination fee, capped at £1,500 which can be added to the loan, and a fixed yearly interest rate of 19.6%. Interest rolls up is capped at 30 months.
The IHT Loan is the second product from Tower Street Finance. We also offer an award-winning Inheritance Advance, a product for Beneficiaries who want to access their inheritance more quickly than the 9 to 12 months it usually takes.
How you can find out more about the IHT Loan
The IHT Loan is a new product from Tower Street Finance that can help executors (or personal representatives if there’s no will) will estates where there is an Inheritance Tax (IHT) liability to pay but no funds available, and it is holding up the legal process.
Find out more by clicking here.