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Understanding UK Inheritance Tax Thresholds

09 January 2024
Taxes and house on wooden blocks: A miniature house symbolizing homeownership, surrounded by wooden blocks representing taxes.

In estate planning, one crucial aspect that cannot go unnoticed is the concept of inheritance tax. In the United Kingdom, assets passed down from generation to generation are taxed according to a set of rules and thresholds that can significantly impact the financial legacy you leave behind. The latest statistics from HMRC found that in the tax year of 2020 to 2021, the total number of UK deaths that resulted in inheritance tax (IHT) charges increased by 17% since the previous tax year (2019-2020). There are complexities within this subject, so it is important to understand the intricacies when helping your family secure their financial future.

So what are the inheritance tax thresholds you need to be aware of? Are there any exemptions? In this article, we will explain:

What are the inheritance tax thresholds in the UK?

The basic inheritance tax threshold allowance is £325,000 and is known as the nil-rate band (NRB). The standard inheritance tax rate is 40% if the estate is valued above the threshold. As of the tax year 2023-24, there is no inheritance tax to be paid if the value of the estate is below the £325,000 threshold. If it is over this amount, approximately 40% will be charged as tax. However, the executor of the will or administrator arranging the payment of IHT does not need to pay it if you leave your assets worth over £325,000 to exempt beneficiaries, such as your spouse, civil partner or charity.

The residence nil-rate band (RNRB) was established in 2017 and is an addition to the basic nil-rate band. If you pass away and your estate totals more than the basic inheritance threshold, your estate may be eligible for the RNRB before the inheritance tax is paid. In order to qualify for the RNRB, you must have a qualifying interest in residential property which is left to your direct descendants. The rules surrounding the application of the RNRB are complex and advice should be sought as to whether it will apply to your estate.

Why must you pay inheritance tax?

Inheritance tax is a type of tax that is applied to the estate of a deceased person. When it comes to valuing an estate, you will need to collect a list of all of the assets and their value at the time of the person’s death, whilst also deducting any debts the person had. An estate can range from money, property and land, to jewellery, cars, and shares.

Are there legitimate ways to reduce inheritance tax obligations?

It is difficult to entirely remove your IHT bill. Ideally, advice should be sought and at Culver Law, we help clients by preparing a plan for your particular circumstances without leaving you short of funds for the remainder of your life. Below are some of the most common measures that can be taken to reduce tax:

Write your will

Writing your will is a responsible and considerate way of ensuring your legacy and financial resources are clear to your loved ones. In some situations, the way your will is written can minimise the Inheritance Tax bill for your estate. It is therefore important to consult a properly qualified professional to ensure that your will is structured in the most tax effective way and the way that best suits your overall family situation.

Gifts

You are eligible to give away up to £3,000 of gifts each tax year before it is added to your estate value. You can choose to split this amount of money or ‘gift’ it to just one person. Examples of this may be to pay towards a family wedding or grandchildren’s savings.

You can make larger gifts over and above £3,000. Once 7 years have passed from the date of the gift no tax will be due on that gift. Should you die within 7 years of making the gift, the value of the gift will be brought back into account when calculating any inheritance tax due on your estate.

You may also gift to charities without a limit, as charity donations are not subject to inheritance tax.

If you wish to remember a charity in your will and the gift amounts to at least 10% of your estate, then any inheritance tax due may be payable at 36% instead of 40%. Again, the rules surrounding this are complex and so advice from a suitably qualified professional should always be sought.

Spend some of your finances and invest in a certain way

Keep your estate below the IHT threshold by spending some of your finances. During your lifetime, you might have the opportunity to invest in experiences such as a memorable holiday, a new vehicle or jewellery, among other possibilities.

Investment opportunities also exist to reduce your IHT bill. Advice should be taken from an independent financial advisor.

Add to your pension savings

You could grow your pension pot by increasing the amount you choose to add. Pensions are not included in your inheritance tax as they do not form part of your estate. However, if you die before the age of 75, your pot can be inherited as a tax-free lump sum of the lifetime allowance, which is £1,073,100. If you die after 75, your beneficiaries who are inheriting your pension will have to pay the highest rate of income tax if they choose to withdraw any of it.

Are there any exemptions?

As previously stated, making a gift to your family or friends while you are still alive is an efficient way to reduce paying more inheritance tax by deducting part of your estate.

Trusts

Creating a trust in your lifetime can be another way to help reduce or exempt an individual from paying inheritance tax, depending on various factors. If the person creating the trust lives for at least seven years after making the transfer, the assets within the trust can become exempt from inheritance tax, gradually reducing the taxable value of the estate.

A discretionary trust is a particularly useful type of trust offering flexibility in distributing assets among beneficiaries. These are particularly useful when there is a large group of potential beneficiaries or where you wish to maintain an element of control.

However, gifts to trust do have tax tax implications of their own and gifts to trust can give rise to an immediate tax charge with further tax payable when distributions are made from the trust.

Another type of trust is what is known as an interest in possession trust (IIP) (often called a life interest trust). Within this trust a specific beneficiary has the advantage of receiving the income generated by the trust assets or can live rent free within a property owned by the trust. Depending on the circumstance of the situation, the assets within the trust may qualify for inheritance tax relief. The biggest advantage with this type of trust is that the main beneficiary never becomes an absolute owner. They therefore can benefit from the asset but cannot sell it or be forced to lose it on divorce, bankruptcy or be tricked out of the property. This can therefore be advantageous in a lot of circumstances.

It is crucial to note that not all trusts can provide exemptions from paying inheritance tax. The terms of nature of the assets play an important role in determining the IHT implications. Trusts have their own set of tax rules and so it is important to weigh up the tax applicable to trusts against any potential tax savings on the beneficiaries.

Business relief

Business relief is a tax relief that is designed to reduce the inheritance tax liability on certain business assets; intended to support small and medium-sized businesses (SMEs). When an individual dies and passes on qualifying business assets, they may be eligible for a reduction in their taxable value, depending on the asset. Business relief can also apply to holdings of non-listed shares. If you have a financial adviser they will be able to advise you on this.

Who can I leave my inheritance to?

Typically, the most common beneficiaries you would often leave your inheritance to are family members - such as spouses, civil partners, children, grandchildren, parents and siblings. You can also choose to leave part or all of your inheritance to close friends, charities, and other relatives.

Under UK law, you are free to leave your estate to whoever you wish provided that your wishes are clearly set out in your will. This means that you can designate your beneficiaries according to your relationship with them, for example, step-children.

Similarly to other non-blood relatives, such as unmarried partners can receive your inheritance. The key is to ensure your will clearly sets out your wish to benefit from your estate. Ambiguous wills can lead to misunderstandings and, possibly, legal challenges.

How is inheritance tax paid?

The executor appointed under a will would typically arrange to pay the inheritance tax, but if there is not a will, the administrator of the estate will organise it on behalf of the deceased person. It is usually paid from the funds left within the estate, or from selling the assets. Where an estate includes property, any inheritance tax attributable to the property can be paid in instalments over ten years instead of an upfront lump sum payment. Such instalments will attract interest until the full inheritance tax liability has been settled.

Can you pay inheritance tax using a life insurance payout?

A life insurance payout can be used to cover the inheritance tax bill. However, whichever policy you decide on needs to be incorporated into the trust so that the value is not added to the estate.

Get expert advice regarding inheritance tax

At Culver Law, we pride ourselves on providing all of our clients with exceptional client care with wills, probate and inheritance disputes. The death of a loved one is a difficult and overwhelming time, only made more complicated and stressful with disputes regarding a loved one’s estate.

We are skilled in providing support for the following:

  • Trust, burial, executor and administration disputes
  • Inheritance act claims
  • Court of Protection disputes
  • Applications to rectify mistakes in wills

For a free, no-obligation telephone consultation, contact us.

T: 0203 633 6226
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Culver Law, London
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London
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0203 633 6226
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