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Inheritance Tax

Candid Statistics
Inheritance Tax - Figures to the end of March 2021
Ratio Change on Year
IHT Nil Rate Band / Average House Price* Ratio (Higher is better) 1.40 -1.47%
Source: * Nationwide.

What is it?

It's a tax paid on your 'estate' (generally everything you own less everything you owe) when you die. It could also be payable on assets you've given away during the last seven years of your life.

How much do I pay?

You pay Inheritance Tax (IHT) at the prevailing rate on the taxable value of your estate above a 'nil rate band', when you die. The tax is deducted from your estate before it's distributed to your beneficiaries, during a process called 'probate'. The IHT rate and nil rate band for the current tax are:

IHT rate Nil Rate Band
40% £325,000*

Any part of your nil rate band not used on your death can be transferred to your surviving spouse when they die. The unused proportion is pro-rated to the prevailing nil rate band when they die.

The nil rate band tends to increase each tax year, but there has been criticism in recent years that the Government has not increased it by anywhere near enough to compensate for soaring house prices, pushing too many people into the IHT net.

To in part counter this the Government added an additional allowance from April 2017. Put simply, if you own a home then you could receive an additional IHT allowance of up to £175,000 each, bringing a couple’s combined IHT allowances to £1 million. There are some caveats: the extra allowance starts at £100,000 from April 2017 and progressively rises to £175,000 in 2020, it falls away on estates over £2 million and the extra allowance can’t exceed the value of your home. There’s a pretty good summary with examples on the Gov.uk website.

How can I reduce/avoid IHT?

Although there are a number of fancy IHT avoidance schemes on the market, there are really only two fundamental ways to reduce or avoid IHT:

  1. Use the various IHT exemptions allowed by HMRC.
  2. Give away assets and live for at least seven years thereafter.
HMRC IHT ExemptionsGive Away Your Assets

Your estate is not subject to IHT on the following:

  • Any part of your estate that passes to your spouse provided you are both domiciled in the UK.
  • Most gifts made more than seven years before your death.
  • Gifts to charities and political parties.
  • Wedding gifts to your son/daughter of up to £5,000. This reduces to £2,500 for gifts to another member of your family when they get married.
  • Annual gifts of up to £3,000 each tax year. You can also carry forward the pervious year's allowance if unused.
  • As many gifts of £250 per person as you wish to make each tax year.
  • Gifts from normal expenditure - this means regular gifts to someone out of your taxed income, not capital (e.g. savings).
  • Maintenance payments to an ex-spouse/civil partner, dependent relatives and children under 18 or in full-time education.

The importance of wills

If you die without making a will (known as 'Intestate') then your estate may not end up as you would have wished and cause a lot of hassle (and potential delay) to your beneficiaries. A will is especially important if you are not married to your partner, as they will not automatically inherit your estate.

If you die intestate your estate will be passed on subject to the following rules (in England & Wales):

If you're married and your estate is worth £250,000 or less (£450,000 if no children)

  • Everything goes to your spouse.

If you're married and your estate is worth over £250,000 (£450,000 if no children)

Your spouse won't automatically get everything, although they will receive:

  • Personal items, such as household articles and cars, but nothing used for business purposes.
  • £250,000 free of tax or £450,000 if there are no children.
  • A life interest in half of the rest of the estate (on his or her death this will pass to the children or as detailed below).

The rest of the estate will be shared equally by the 'next in line', in the following order (i.e. if no surviving children then it passes to grandchildren and so on...):

  • Children - grandchildren - parents - brothers/sisters (who shared the same two parents as the deceased).
  • If the deceased has none of the above, the spouse will get everything.

If you are partners but aren't married or in a civil partnership

Your partner won't automatically receive a share of your estate when you die unless you have made a will.

If there is no surviving spouse

The estate is distributed equally to the 'next in line', in the following order:

  • Children - parents - brothers/sisters (who shared the same two parents as the deceased) - half brothers/sisters - grandparents - aunts/uncles - half aunts/uncles.
  • If the deceased has none of the above, the estate will pass to the Crown.

How do I make a will?

A solicitor can draw up a will to meet your requirements, usually for a fee of around £150 upwards. The exact amount will depend on your location and the complexity of your requirements. But make sure they DON'T include themselves as the executor, else your estate could end up paying a small fortune in fees (see the probate section below).

If your needs are straightforward you could save money by using a DIY will kit. These are available for around £10 and allow you to create your own will using standard templates. You simply need to complete the paperwork and ensure it is signed by two independent witnesses (who cannot be beneficiaries or their spouses).

If your circumstances/wishes change you can either amend your will by adding supplementary changes (known as 'codicils') or write a new will altogether.

What's probate?

When you die your estate (unless it's valued below £5,000) will need to go through a legal process called probate to ensure inheritance tax is paid and that everyone mentioned in the will gets their fair share.

The process, which mostly involves lots of paperwork, usually takes a few months. It's carried out by the executor named in your will, which could be one or more trusted family members or friends, or a professional such as a solicitor or accountant.

Some probate profesionals, especially banks, charge sky high fees which really can't be justified. Name them as executor in your will and you could be handing them an open cheque on your estate.

Most people have little understanding of (or interest in) probate unless they've had to deal with the death of a close relative. But it's a very important process which, handled badly, could significantly delay beneficiaries getting what's due from the estate and/or cost a small fortune.

So who should you name as the executor of your estate? (i.e. the person who'll be responsible for handling probate when you die). The cheapest option would be a close relative or friend you can trust to complete the necessary tasks and paperwork – around a third of people choose this route. On a straightforward estate this is likely to take around 20-30 hours of their time over a period of several months. If professional help is needed they can then find a cost effective deal – at least your estate won’t be locked into using a potentially expensive probate firm from the outset.

If you decide you’d rather appoint a probate professional, such as a solicitor or accountant, as the executor of your will then shop around to ensure a competitive fee. You should generally avoid banks as they have a reputation for charging exorbitant fees.

Unlike funeral costs, probate fees cannot be deducted from your estate to avoid inheritance tax, unless you pay them in advance while you're still alive.

Using a will to avoid inheritance tax

If your will passes your entire estate to your surviving spouse when you die then no IHT is payable. Your full nil rate band can then be transferred (at the prevailing allowance) to your spouse when they die.

Candid Example Mr A dies leaving his share of their £700,000 estate to his wife, Mrs A. No IHT is payable at that time and his nil rate band is to be transferred to Mrs A at the time of her death. When Mrs A dies several years later the nil rate band stands at £360,000. Mr & Mrs A's nil rate bands can be combined to give a total allowance of £720,000, meaning no IHT is payable.

Deed of variation

After someone dies their will can be changed within two years of their death using a Deed of Variation, useful if changes can be used to reduce IHT or capital gains tax liabilities by making the will more tax efficient (or perhaps because beneficiaries want to share the estate more fairly amongst themselves). All affected beneficiaries must agree to any changes, no-one can be compensated for anything they give up and none of the assets can be affected by a gift with reservation.

What are trusts?

Unit TrustsYou've decided that you'd like to reduce the value of your estate by giving some money to your grandchildren (and hoping that you live for at least seven years afterwards) , but you're worried they're too young to be financially responsible and might fritter the money away.

This is an example of where trusts can help. In general terms, they allow you to give money/assets away now but retain control over who gets them and when.

Bear in mind it's a one-way process, once you gift money/assets into the trust you can't normally take them back unless you dissolve the trust in which case the assets will pass back into your estate (after paying any income or capital gains tax owed). However, you may be able to make withdrawals while you're alive if you use a loan trust or discounted gift trust (more details below).

Should I use one?

If you have assets in excess of your nil rate band that you're comfortable giving away, to reduce the value of your estate, then using a trust might make sense. The key is whether you want any control over what happens to the assets once you've given them away. If you want control then a trust could achieve this, albeit at a cost, else simply give the assets away and wave bye bye.

Also bear in mind that tax changes introduced in March 2006 have made certain trusts far less attractive for IHT avoidance than they once were. Yet another example of Gordon Brown tightening his taxation net.

Trust jargon

Trusts have their own set of jargon, the main words you need to understand are below:

Trust DeedSettlorTrusteesBeneficiariesPET

This is the document that creates the trust. It contains details of who is setting up the trust, who's responsible for looking after it and who stands to benefit, along with more general details about the trust.

Types of trust

There's quite a few different types of trust. The main ones used for inheritance tax planning are outlined below:

BareInterest In PossessionDiscretionaryAcc & MaintenanceLoanDiscounted Gift

This is the simplest type of trust. The settlor gifts assets into the trust and the beneficiary has 'absolute' entitlement to the assets. They're held in the name of the trustee until the beneficiary reaches age 18, at which point the assets pass to them. The beneficiary is liable to any income or capital gains tax that might be due on the assets while they're held in the trust.

Basically, once the assets have been placed into the trust then nothing can be changed, so it's a very rigid one-way process.

This is a popular trust with grandparents who wish to give money to a grandchild but doesn't want them to receive it until they reach age 18. The money is treated as a gift (hence regarded as a PET) and although the child is liable to tax on the interest received they're probably a non-taxpayer so this isn't an issue. Most banks and building societies offer a free form allowing a bare trust to be set up in conjunction with one of their savings accounts (as do a few investment trust managers).

Both loan and discounted gift trusts can be set up as 'bare' or 'absolute' trusts rather than discretionary, hence avoiding potential 'chargeable lifetime transfer' and 'periodic charge' taxes. However, they're totally inflexible as nothing can be changed once the trust is set up, making them unattractive in most situations.

Should I get advice?

Although the concept is simple, trust planning can get complicated. If you're not sure what you're doing it's worth seeking specialist advice from a solicitor and/or an independent financial adviser who specialises in trust work. They might try to sell you investments to place inside the trust, which is likely to be far more profitable for them than setting up the trust itself, so be wary. You may want advice on investments too, but the professional advising on the trust may not be the best, or most cost effective, option for investment advice or management. You can find out more about investments by reading the Candid Money guide to investing here.

Inheritance Tax Jargon

Here's some of the more common inheritance tax jargon you might come across:

Accumulation and Maintenance Trust A special type of discretionary trust designed specifically for children and grandchildren. Often used to pay for education costs.
Discretionary TrustsA trust that allows the people who look after the assets (trustees) to pick and choose how to allocate income to beneficiaries.
Interest In Possession TrustA trust that allows assets to pass to dependants while paying an income to someone else.
IntestateThe name given to dying without making a Will. Can complicate and delay the subsequent passing of your estate to beneficiaries.
Nil Rate BandAn allowance, offset against the value of your estate when you die, below which no inheritance tax is payable.
Potentially Exempt Transfer A PET is a gift that remains subject to inheritance tax if you die within seven years.
ProbateThe process where inheritance tax is deducted from an estate before it's distributed to the beneficiaries.
Taper ReliefA reducing scale of inheritance tax that applies to potentially exempt transfers over seven years after the gift is made.