Whether you’re the recipient of an inheritance or you’re planning for the financial future of your loved ones, it’s important to understand the ins and outs of inheritance tax. Read on for valuable information like what an inheritance tax is, its threshold, and whether it can be minimised or not.
When Do You Start Paying Inheritance Tax?
If you leave an estate that is worth less than 325,000 GBP, no inheritance tax will be applied. There is only a tax to pay when your estate exceeds this value, unless everything above this threshold is left to one of the following recipients:
- Your spouse or civil partner
- A charity
- A community sports club
There’s no upper limit to the amount of inheritance tax that can be demanded. The tax is applied when a person dies; however, the heirs of an inheritance may even have to pay tax on property, money, and other possessions that were given to them before the death.
What Is The Inheritance Tax?
Inheritance tax is a tax applied to the estate of someone who has died. It was introduced in its current form in the year 1986. Before that, estates were subject to capital transfer tax. Inheritance tax is still considered a “transfer tax,” a tax on the transfer of property from one owner to another.
When someone dies, they may have money, property, or other valuable items that they wish to leave to their loved ones or specific organisations. This is called their estate. If the estate exceeds a certain value, the government has the right to demand a certain percentage of this amount. This is called inheritance tax.
Some important exceptions apply. For example, small estates under the value of 325,000 GBP are not subject to inheritance tax. Also, if the property exists outside of the UK and it is due to be given to someone who is also outside of the UK, inheritance tax will not apply to this transfer.
What Is The Inheritance Tax Threshold?
An estate will not be subject to inheritance tax until it reaches the value of 325,000 GBP. For this reason, only 1 in 20 UK households actually pay inheritance tax. Most estates do not exceed this amount, and so they aren’t taxed. In 2020, the government received approximately 5.2billion GBP in inheritance tax payments.
It should be noted that, although a relatively small percentage of households exceeds the inheritance tax threshold, this tax is not applied equally around the world. The UK has the fourth highest inheritance tax rate of all countries, equal to that of the USA but less than Japan, South Korea, and France. Some countries, such as Sweden and Portugal, do not charge any inheritance tax, regardless of the estate’s value.
How Much Is UK Inheritance Tax?
The amount an estate will be charged in inheritance tax depends on its value. If it’s less than 325,000 GBP, then it won’t be subject to any inheritance tax. This is the case for the vast majority of households in the UK.
Anything above this threshold will face a tax of 40% of its value. This is reduced to 36% if at least 10% of the estate’s value is left to a charity. There is also a noteworthy exception known as the “Main Residence Band” or the “Resident Nil Rate Band” which increases the threshold when the main residence is left to children or grandchildren.
Calculating Inheritance Tax: Example
Here are three examples of how inheritance tax would be calculated in different scenarios.
If the estate is valued at 300,000 GBP, no inheritance tax would be applied. It does not meet the minimum threshold of 325,000 GBP.
If the estate is valued at 425,000 GBP, no inheritance tax would be applied on the first 325,000 GBP. However, a tax of 40% would apply to the remaining 10,000 GBP. 4000 GP would be paid in inheritance tax.
If the estate is valued at 425,000 GBP, but the 10,000 GBP that exceeds the tax threshold is donated entirely to charity, no inheritance tax would be applied.
How Do You Minimise Inheritance Tax?
As you can see from the above example, it’s possible to entirely eliminate inheritance tax – even if you exceed the threshold. However, the exceeding amount must be given to a spouse, a charity, or a community sports club.
You could also give money away as gifts to family or friends in order to avoid inheritance tax after your death. These sums will not be included in the value of your estate after 7 years. However, you’re only able to give away 3000 GBP per year.
Another way to minimise inheritance tax is through the Residence Nil Rate Band.
Minimising Inheritance Tax: The Residence Nil Rate Band (Rnrb)
If the main residence is being left to direct descendants (children or grandchildren) then the inheritance tax threshold is increased by 175,000 GBP. That means that an estate up to the value of 500,000 GBP could be exempt from paying any inheritance tax at all.
The threshold amount of the Residence Nil Rate Band increases year by year in accordance with inflation. However, it should be noted that this threshold increase is limited for those who have estates that exceed the value of 2 million GBP.
Is Inheritance Tax Avoidable?
You can avoid inheritance tax using a number of strategies, including the following:
- Spending all money that exceeds the inheritance tax threshold in your own lifetime.
- Giving money as gifts during your lifetime.
- Leaving all money or property in excess of the 325,000 GBP threshold to a spouse, charity, or community sports team.
- Moving money into pension plans or life insurance.
However, if you’re domiciled in the UK, you have an estate exceeding the threshold value, and your estate is not eligible for any of the above loopholes, then inheritance tax legally must be applied.
What If No Inheritance Tax Is Due?
If the estate falls is one of the roughly 96% in the UK that don’t exceed the 325,000 GBP threshold, then no inheritance tax is due! That means the heirs will have unhindered access to the entire estate. This is good news for those who want to be sure that their loved ones are financially secure, even and especially in their absence.
