Reviewed by James Badcock
The prospect of having to pay a hefty inheritance tax bill in the UK is something that can concern people as their parents age, particularly as property prices in the UK have increased substantially over the years.
Put very simply, if a person’s estate is worth more than £325,000, or if they have made gifts during their lifetime which taken together with their estate exceed £325,000, then any excess may be subject to tax at 40%.
A common misconception is that inheritance tax is paid by the person, or people, who inherit after someone dies. In fact, inheritance tax is paid from the deceased person’s estate by the executor of the will, before the beneficiaries of the will receive what’s been left to them.
If you’re the executor of a will, you only have to pay inheritance tax from the estate you’re administering if the value of the estate is above what’s known as the inheritance tax nil rate band, often referred to as the inheritance tax threshold. While that may make things sound a little simpler, that isn’t always so, especially if the bulk of the estate is tied up in property or other non-liquid assets.
HM Revenue and Customs expect inheritance tax to be paid, by the latest, six months after a person has died. Although inheritance tax can be paid on some assets in installments over ten years, interest will be chargeable, and you may still have some inheritance tax to pay within a relatively brief period of time. There are some things though that can be done while your parent is still alive to try to legally reduce inheritance tax, from giving gifts while they’re alive, to taking advantage of reliefs.
Read on to learn more about inheritance tax and how it can potentially be reduced with proper planning.
Note: The information provided in this article is for general informational purposes only and should not be considered a substitute for professional advice.
What exactly is inheritance tax?
Inheritance tax may have been created with seemingly good intentions – it was essentially meant to create a dispersal of wealth from the richer to the poorer. The UK tax office isn’t Robin Hood though so whether the money actually benefits the less fortunate is anyone’s guess.
According to statistics published by GOV.UK, only around 4% of estates belonging to the UK’s deceased are liable for inheritance tax. That’s a relatively small proportion, but not helpful if your parent’s estate or the estate you’re administering is one of them.
If your parent’s taxable estate is valued at more than the nil rate band of £325,000 then a good-sized chunk of the monetary value of their assets may go to the government. Thankfully, as long as your parent, or parents, plan ahead there are ways to reduce the amount of inheritance tax that needs to be paid after they die.
How is inheritance tax calculated?
Currently, the inheritance tax threshold (nil rate band) is set at £325,000. Whatever value an estate has over that amount is liable for taxation at 40%. For example – on an estate worth £425,000, the amount that would be subject to inheritance tax is £100,000. So the inheritance tax due would be £40,000 (40% of £100,000). This means the amount left to beneficiaries of the estate would be £385,000.
Where someone leaves their assets to their spouse or civil partner, then there is an inheritance tax exemption (although the position is more complicated if one of the individuals is not domiciled in the UK). Then, because the nil rate band is not used on the death of the first spouse or civil partner, it can be available on the second death (i.e. two nil rate bands may be available, a total of £650,000).
There are circumstances where the nil rate band may not be available, for example where there have been lifetime gifts or transfers to trusts, within a certain time period before death.
In addition to the nil rate band, there is also what is known as the main residence nil rate band. This can provide an additional tax-free amount of £175,000, where the value of the deceased’s estate exceeds their normal nil rate band as a result of the value of their main residence, and where they leave their residence to a direct descendant. As with the normal nil rate band, this extra nil rate band can be transferred to a surviving spouse or civil partner, where it is not used on the first death. However, there are some complexities to be aware of, and also the additional nil rate band ceases to be available in full if an individual’s estate exceeds £2m in value.
Reducing inheritance tax by planning ahead
To be able to reduce the amount of inheritance tax that will have to be paid on your parent’s estate, it’s vital that they plan ahead. It’s generally not something you can reduce after they have passed away. They need to do it while they are still alive.
Here are some things things they can consider to reduce inheritance tax:
1. Put in place a Will and use the spouse exemption
If your parents do not have a Will, then the statutory intestacy rules will apply, which will mean that part of their taxabale estate may pass to their children, rather than their surviving spouse. These assets will then be taxed, whereas if they had passed to the spouse they would not have been.
Therefore, it is important to put in place a Will to ensure your parents’ assets are left in a tax efficient way. It is still possible to ensure that assets eventually pass to their children (or other heirs), if the Will is structured properly. Sophisticated Wills which deal with these complexities require advice from a solicitor or professional will writer.
2. Leave their home to you or another direct descendant
This is one of the main things people do to increase their tax inheritance threshold. The additional nil rate band referred to above will only be available if they leave their home to a direct descendant in their will.
If your parent has a large house they can no longer manage, they may want to consider gifting it to you or someone else while they are still alive and they go to live somewhere else. They can also gift their house and continue to live in it as long as they can prove they pay market rent to you or whoever in the family is the new owner. In either case the property would no longer be classed as part of their estate and not liable for inheritance tax. But, and there’s always a but, there are rules on this type of tax avoidance, namely the seven-year rule, which requires the gifter to live for seven years after gifting. Also, it should be noted that where a lifetime gift is made, neither the spouse exemption nor the additional nil rate band will be available if inheritance tax becomes payable because they die within seven years. Furthermore, the capital gains tax and stamp duty land tax consequences of any gift should be considered.
3. Make charitable donations
If the entire value of the estate that’s above the nil rate band is donated to charity (provided that charity or charities are registered in the UK) then it’s not taxed. Understandably, when that’s a substantial amount, you, or your parent, may not want that to happen. Another option is to donate 10% of the estate’s net value to charity instead. By doing that, anything in the estate above the tax inheritance threshold will only be taxed at 36%. Not much of a reduction, but a reduction nonetheless.
4. Use their annual tax-free gift allowance
Everyone is allowed to give away up to £3,000 of their money or belongings per year which is exempt from taxation. If they gift more and then die within seven years then the seven-year rule applies and the gift is classed as part of their estate and possibly liable for inheritance tax. It could also happen that the person who received the gift becomes liable to pay tax on it.
It’s a good idea to check up what is classed as a gift by HMRC and understand more about the regulations concerning inheritance tax that are attached to gifting during someone’s lifetime. It can get complicated. For example, you may gift £250 to as many people as you want a year, but not if you’ve already used the £3,000 allowance on them. There are also multiple occasions where you may give someone more even though you’ve used the allowance. You can find out more about gifting and exemptions here on GOV.UK.
5. Set up a trust
A trust is a legal arrangement where trustees hold assets for the benefit of others. Trusts can be set up for a number of reasons and this can be done during their lifetime, or under the terms of your parent’s Will. Trusts can be useful where beneficiaries will be young, or need to be protected from wealth, where there are more complicated families (for example children from a previous marriage), and where there are business or agricultural assets.
The inheritance tax treatment of trusts is complicated. For example, when trusts are set up during lifetime, then payments made into a trust that are higher than the inheritance tax threshold can be subject to an immediate inheritance tax charge of 20%, if there is no tax relief available. The seven-year rule also applies to assets held in trust so if the settlor of the trust dies within seven years, the full 40% inheritance tax has to be paid. Trusts can also be subject to ten-yearly charges of up to 6% of the value of the assets, and similar charges when assets are distributed from the trust.
For these reasons it is vital to take professional advice if you are interested in setting up trusts which are created during someone’s lifetime, or on their death.
6. Life insurance
Where it is not possible to put in place planning which will avoid an inheritance tax charge, your parents may wish to obtain life insurance which will pay for the inheritance tax on their death. It is better to consider this earlier in life, as when they are old or in ill health it may be expensive or impossible to obtain life insurance. Many different types of life insurance are available to deal with different scenarios. A financial adviser can advise on the options which are available.
7. Get professional advice
Inheritance tax is, without a doubt, complicated. Setting up trusts and the complexity of the regulations around gifting can be very confusing. The larger your parent’s estate is, the more complicated things will get. Getting professional advice about inheritance tax from a reputable financial advisor or tax adviser can alleviate a lot of the worry involved. While the average hourly rate for an independent financial advisor can be in the region of £150, and specialist tax advisers can be considerably more, that’s nothing compared to how much they’ll save you on your inheritance tax bill.
Reducing inheritance tax after your parent has passed
It’s not always possible to get your parent or parents to plan ahead in an attempt to reduce inheritance tax. It may be that they don’t want to or that they’ve now sadly passed on and you’re dealing with their affairs.
It is sometimes possible to vary the way in which your parent has left their assets, to reduce the inheritance tax payable. For example, if your parent did not make full use of the spouse exemption, leaving assets to their children instead, the children could vary the will to give the assets to the surviving spouse, who could later gift them to the children. This could reduce the overall amount of tax payable.
Approaching discussions on inheritance tax
Discussing inheritance tax with parents can be a delicate topic and difficult to bring up, so it is crucial to approach discussions with sensitivity and caution.
Finances are often considered a private matter. Your parents may feel uncomfortable discussing their wealth, assets, or future plans, especially if they view these matters as personal and not something to be shared or discussed with their children.
Added to this, inheritance involves not only financial matters but also emotional ties and family dynamics. It might bring up uncomfortable feelings about mortality, family relationships, and the distribution of wealth.
In some cases, bringing up inheritance tax can also inadvertently lead parents to believe their children are more concerned about what they will inherit rather than their well-being. This can create a perception of pressure or expectation regarding inheritance, and place stress or strain on the relationship.
If you can persuade your parent to plan ahead for inheritance tax then that’s a good thing. There are some interesting options out there for reducing inheritance tax and because of the seven-year rule, the sooner they’re implemented the better. On the other hand, your parent may not want to consider any of them and that’s a choice you will need to respect. But at least you’re informed and you’ll know what to do when the inevitable happens.
- How much can you inherit from your parents without paying taxes in the UK?
The inheritance tax threshold currently stands at £325,000. This can be increased to £500,000 if your parent leaves you their main residence.
- Do I have to pay tax in the UK on an inheritance from overseas?
If the inheritance is received from a UK domiciled or deemed domiciled person, then inheritance tax may be due. If the overseas asset is received from a person who is not domiciled or deemed domiciled in the UK, then no inheritance tax should be due. In both cases, it may be that there is foreign tax payable.
- Does a non-resident have to pay inheritance tax in the UK?
The inheritance tax is paid by the deceased estate before monies are paid to the beneficiaries of the will.
- Is there going to be a change in inheritance tax in the UK?
There may be. There has been significant discussion about the perceived unfairness and unpopularity of inheritance tax, and there have been rumours that the Government may cut inheritance tax. It now seems likely that any change will depend on the outcome of the General Election, which is due to be held by January 2025.