What is inheritance tax?
When you die, it may well be that your heirs will have to pay tax on the assets you leave them. Alternatively, if you’re an inheritor, it’s the tax you may have to pay on an estate or assets that have been left to you.
The basic rate of tax on inheritance is 40%, and is payable on savings, property and other assets, after the expenses of the funeral are deducted. But it’s a lot more complicated than that oh-so-simple picture. For starters, there are tax-free allowances, thresholds and all manner of loopholes. When it comes to inheritance tax, even the small print has its own small print.
What is the threshold for inheritance tax?
The standard threshold for inheritance tax is £325,000. Leave assets worth less than that, and no tax is payable. As an example, if you leave £400,000, then only £75,000 of that is taxable, at 40%. However, there are numerous subclauses to this that can muddy the water. For example, since 2017 there has been an additional transferable allowance of £175,000 that applies when leaving property to a family member, increasing the threshold to £500,000.
However, you have to be leaving it to a direct descendant, such as a child or grandchild. Also, if you’re passing on your property as a married couple, you can double the ‘nil rate band’ to £1m. Sounds simple? Well, don’t forget that this can only apply to one property, you must have lived in at some point, and the tax benefits taper off in estates worth more than £2m. Told you it was complicated.
How do you avoid paying inheritance tax?
Put simply, if you’re a single person, then chances are you’ll be liable for a tax bill if your estate is worth more than £325,000, but there are steps you can take to reduce the amount of tax payable by those that are in line to inherit it. If you’re married or in a civil partnership, the picture is much clearer - your partner can inherit your estate without paying tax.
As mentioned above, you have a tax-free allowance, and the additional residence nil-rate band of £175,000, which can lower the tax bill. Ensure you leave a will, so that your intentions are clear. You can also further reduce inheritance tax by leaving money to a political party, amateur sports club or UK charity. If you leave at least 10% of your taxable estate to one of these, the tax rate on the rest of your estate falls to 36%. You’ll need advice to know if your estate is large enough to make this worthwhile.
Who doesn’t pay inheritance tax?
This is a simple one - spouses and civil partners. Of course, they’ll need to be domiciled in the UK, otherwise they just get the standard £325,000 exemption. Charities and political parties also don’t have to pay tax on any gifts you leave them. Also, recipients of small gifts under £250 don’t have to pay tax, while there’s also an annual exemption of £3,000 that allows you to give gifts up to that amount away each year.
What is the 7 year rule for inheritance tax?
Not all inheritances happen after death. You may wish to donate your estate while still alive. In this case, the seven year rule applies. This means that, as long as you live seven years after making any gifts from your estate, no inheritance tax is due on said gifts. These gifts can include money, stocks and shares, property, land and personal goods.
As ever, there are some complexities to consider, so it’s best practice to get professional advice before making gifts from your estate. Inheritance tax liability can be affected by what the gift is, when it’s gifted and who the recipient is. The tax relief tapers depending on how many years pass - if you die within three years of making the gift, it’s taxed at 40%, dropping gradually to zero after seven years.
Are ISAs subject to inheritance tax?
While an ISA - or a whole bunch of them - can be wonderful tax-efficient investments in life, they stop being so in death. Unless you’re passing them on to your civil partner or spouse, they become liable for inheritance tax at 40%, if your estate is above the tax-free allowance.
It’s also not too simple for the partner or spouse. They get an APS ISA allowance on your death, but the funds have to remain in the ISA to benefit from tax exemptions. When they die, the ISA will then possibly be subject to tax. Is there a work around? Investment in certain AIM stocks can reduce the inheritance tax burden. Want advice on this? We’ve got you.