A Beginner's Guide to Inheritance Tax

Inheritance Tax (IHT) is a tax on the estate (property, money, and possessions) of someone who has died. While most estates do not end up paying IHT, it is worth understanding how it works, especially if your estate could be above the threshold.

The Nil-Rate Band

Everyone has an IHT nil-rate band of £325,000. This means the first £325,000 of your estate is tax-free. Anything above this threshold is taxed at 40%.

The nil-rate band has been frozen at £325,000 since 2009 and is currently expected to remain at this level until at least April 2028.

The Residence Nil-Rate Band

If you leave your main home to your children or grandchildren (direct descendants), you may qualify for an additional residence nil-rate band (RNRB) of up to £175,000.

Combined with the standard nil-rate band, this gives an individual a potential tax-free threshold of £500,000. For married couples and civil partners who can transfer unused allowances, the combined threshold can be up to £1,000,000.

The RNRB tapers away for estates worth more than £2 million, reducing by £1 for every £2 above that threshold.

Transfers Between Spouses and Civil Partners

Assets passed between married couples or civil partners are exempt from IHT, regardless of value. This applies during lifetime and on death.

When the first spouse dies, any unused nil-rate band and residence nil-rate band can be transferred to the surviving spouse, potentially doubling their available threshold.

The Seven-Year Rule and Gifting

Gifts made during your lifetime can reduce the value of your estate for IHT purposes, but there are important rules:

• Gifts made more than 7 years before death are completely outside the estate
• Gifts made within 7 years of death may be subject to IHT on a sliding scale (taper relief)
• You can give away £3,000 per year under the annual gift exemption (and carry forward one unused year)
• Small gifts of up to £250 per person per year are exempt
• Wedding gifts up to £5,000 (to a child), £2,500 (to a grandchild), or £1,000 (to anyone else) are exempt
• Regular gifts from surplus income (not affecting your standard of living) can also be exempt

Other Exemptions

Several other IHT exemptions exist:

• Gifts to UK-registered charities are exempt. If you leave at least 10% of your net estate to charity, the IHT rate on the rest reduces from 40% to 36%.
• Business Property Relief can reduce the taxable value of qualifying business assets by 50% or 100%.
• Agricultural Property Relief applies to qualifying farmland and farm buildings.
• Certain pensions (defined contribution pensions that have not been accessed) are typically outside your estate for IHT.

Paying Inheritance Tax

IHT is usually paid by the executor of the estate from the estate's assets before beneficiaries receive their inheritance. It must generally be paid within six months of the end of the month of death.

For property, there is an option to pay IHT in annual instalments over 10 years, which can help if the estate includes a property that takes time to sell.