In England and Wales, there may be an inheritance tax to pay when someone dies. Before anything can be passed on to a beneficiary, inheritance tax is normally paid out of the estate as a debt. The executors, not the beneficiaries, are responsible for paying inheritance tax.
What is inheritance tax?
The inheritance tax is a tax on property and funds acquired by gift or inheritance, and it was first implemented in 1986. When inheritance tax is due, the standard rate is 40%. However, there is a tax-free threshold, analogous to the income tax, that must be met before any tax is due. The current exempt public income is £325,000.
So, for example, if the value of your estate is £400,000 and your tax-free threshold is £325,000, your estate would be exempt from taxation. The applicable inheritance tax rate is 40% of $75,000 (£400,000–£325,000). The standard rate of 40% is reduced to 36% when more than 10% of an estate’s value is left to charity. If your primary residence is being transferred to direct descendants, such as children, after your death, you may be eligible for an additional tax-free allowance of £175,000. This means that your total allowance would be £500,000 prior to the application of the 40% tax rate.
If you are married and leave everything to your spouse or civil partner, spousal exemption will benefit your estate. All assets passing to a surviving spouse or civil partner are tax-free and do not count against your tax-free allowances. This means that your estate will benefit from both sets of tax-free allowances after your death. Thus, if you are married or in a civil partnership and bequeath everything to your spouse or civil partner, everything you leave them is tax-free. In addition, they inherit your unused tax exemptions of £325,000 and £175,000. Upon the death of your spouse or civil partner, if they have not remarried, their estate is entitled to a tax-free allowance of up to £1,000,000.
There are a variety of additional estate-reduction strategies available. One such method is transferring assets into a trust that satisfies certain conditions so that they do not form part of your estate and could save you money upon your death. Trusts can be an efficient method of reducing inheritance tax, but you should always seek professional advice before establishing one. Trustees are responsible for purchasing, selling, and investing the trust’s assets responsibly; documents should also be kept of all gifts made, as HMRC may require them to determine the amount of inheritance tax that must be paid upon your demise.
Using your annual gifting allowances is another effective method for minimising your inheritance tax liability. Speak with one of the senior advisors for more guidance on this topic. We can assist you in calculating potential IHT taxes and outlining the necessary measures to minimise them. Other tax reliefs, such as business relief and agricultural relief, enable some assets to be transferred without incurring any inheritance tax or with a reduced bill.
What assets comprise your estate?
To begin, make sure you have an exact inventory of all the assets in your estate. Seeking professional advice (such as from an inheritance tax adviser or financial planner) may be necessary if necessary. If your estate is complicated enough, these professionals may also be able to assist you with this element of planning. This may entail estimating the overall worth of your estate for probate and administration, which may have an impact on your tax liability on other assets. It is critical to get professional counsel to fully comprehend the ramifications of these assets.
For Inheritance Tax reasons, some assets are not included in your Estate. Certain life insurance plans, pension money, and assets held in trust are examples of this.
Some people prefer to give money or property away during their lifetime in order to lower the size of their estate and perhaps reduce inheritance tax obligations, typically by establishing a trust. A trust is a legal arrangement in which money or property is handed to another person for the care of a third-party beneficiary (your beneficiary), with you determining when and how beneficiaries may access these monies.
The 7-year rule
Gifting property into trusts or giving assets away outside of your gifting allowances will exclude it from IHT if you survive seven years after donating it, making it a “Potentially Exempt Transfer (PET)”. However, if you die before the 7-year period is over, this gift or transfer may still be liable to IHT, albeit at a lower rate.
It is vital to highlight that the 7-year rule does not apply to a gift from which you continue to profit. A Gift with Reservation of Benefit (GROB) is what this is. These types of presents could include a gift of property in which you continue to reside for free. For IHT reasons, this donation would still be considered part of your estate.
When must Inheritance Tax be paid?
Generally, inheritance tax must be paid within six months of the end of the month in which the decedent died. This deadline applies to the estate tax and any related tax on gifts made within seven years prior to death. To avoid penalties and interest, it is essential to comprehend and fulfil your payment obligations. Arrangements can be made with HMRC to pay the IHT account over time, but interest will be added, and the estate cannot be settled until the IHT is paid.
