Inheritance tax is a charge that can be applied on the estate (the property, money and possessions) left behind when someone dies.
You shouldn’t need to worry about IHT if:
- Your estate is worth less than the current IHT threshold of £325,000 (this is known as the “nil-rate band”)
- You leave everything to an exempt beneficiary, such as a charity or a community amateur sports club
If your estate is worth more than £325,000, anything above this threshold could be subject to IHT at a rate of 40%.
Some homeowners could pass on up to £500,000 IHT free: the nil-rate band of £325,000 plus the residence nil-rate band, set at £175,000 from 6 April 2020.
Remember, tax rules can change and tax benefits depend on circumstances.
IHT perks for some couples
Married couples and civil partners enjoy potentially significant perks:
- Anything you pass on to your spouse or civil partner is IHT free. This applies even if you leave your whole estate – irrespective of its value – to them.
- The nil-rate band is transferable. This means it is possible to benefit from a deceased spouse's or civil partner’s unused nil-rate bands.
Residence nil-rate band: what it is and how it works
The residence nil-rate band was introduced in April 2017 to make it easier to pass on a family home tax efficiently.
It is an additional nil-rate band which applies to an individual’s interest in a residential property.
It is currently £175,000 (from 6 April 2020) and is expected to increase in line with the Consumer Price Index (CPI) each year.
So, currently a single person could have a total IHT-free allowance of £500,000 (£325,000 nil-rate band, plus £175,000 residence nil-rate band).
Whilst anyone can benefit from the nil-rate band of £325,000, the residence nil-rate band comes with some significant restrictions:
- It only applies to one property which has been at some point your ‘residence’, provided you owned it on or after 8 July 2015. A property that has never been your residence does not qualify, nor might investment properties.
- It only applies if you pass your home on to a direct descendant. This includes your children (also step-children and adopted children) and their children. So anybody without direct descendants cannot benefit.
- If your estate is worth over £2 million, the residence nil-rate band will be tapered. For every £2 your estate is over £2 million (after deducting liabilities but before reliefs and exemptions), the residence nil-rate band will decrease by £1. That means that at £2,350,000 your residence nil-rate band will be zero.
IHT nil-rate bands at a glance
|Nil-rate band||Residence nil-rate band||Total for a single person||Total for a couple*|
The above table is a brief outline only: there are more detailed conditions and rules which you should consider: this can be a complex topic so if you are not sure please seek advice. Tax rules can change and tax benefits depend on circumstances.
What forms part of someone's estate?
Broadly speaking, the value of an estate is the total value of someone's assets, minus any liabilities, at the time of death.
Assets may include:
- Value of main home
- Other properties, such as business property or land
- Cars, boats, fine art, fine wine, etc.
- Home contents and personal effects
- Cash held in bank and building society accounts
- Life insurance policies (if not held in trust)
- Pensions lump sum (if not held in trust)
- Gifts made in the seven years prior to the death
It’s important to note pension or drawdown plans are not normally included as they typically sit outside of your estate at death for IHT purposes. The rules can be complex: if you’re not sure please seek advice.Liabilities may include:
- Utility bills
- Loans, hire purchase, credit cards and other debts
- A reasonable funeral bill
The valuation of an estate is essential in determining if any inheritance tax is due and how much. To calculate this, any available reliefs, e.g. business property relief, must be taken into account.
It is common to use a probate solicitor or specialist to help with estate valuation and IHT calculation.
What does not normally form part of someone’s estate?
Broadly speaking, any assets to which you're not beneficially entitled should be outside of your estate for inheritance tax purposes.
These may include:
- Gifts – including small gifts (typically up to £250) and any larger gifts given at least seven years prior to death (there are also other gifts that do not count)
- ISA Additional Permitted Subscription – this is a one-off ISA allowance that anyone who was married or in a civil partnership with someone who died on or after 3 December 2014 can apply for
- Any assets held in trust, including life insurance policies and pension lump sums
- Pension and drawdown plans
Who pays inheritance tax?
Inheritance tax is a charge on the estate, rather than on individuals. It is normally paid out of the estate before the estate can be distributed to any beneficiaries.
In practice, the IHT payment – alongside the payment of any debts and liabilities – will normally be arranged by the executor of the will or, in absence of a will, by the estate administrator.
When does IHT need to be paid?
IHT should normally be paid by the end of the sixth month after someone died. If this deadline is missed, HMRC will charge interest.
This is a broad summary of a complex topic. Tax rules can change and tax benefits depend on circumstances. If you are not sure please seek advice.
What are the options to protect my estate from IHT?
If you are concerned your estate might be subject to IHT, there are several ways to mitigate the impact.
The main IHT-mitigation strategies include:
- Making a will
This will help ensure your estate is passed on tax efficiently. In absence of a will, intestacy rules will apply, which could result in an avoidable IHT bill.
- Giving money away
Small gifts should be IHT free, as should be regular gifts out of income. Larger gifts are completely IHT free only if you live at least seven years after the gift.
- Establishing a trust
A trust is an often-complex legal arrangement. Usually, when you put any assets in a trust, you no longer own them, so they’re not part of your estate for IHT purposes. However, like with larger gifts, a seven-year rule applies.
- Investing in companies that qualify for Business Property Relief (BPR)
After two years the investment should become IHT free, provided you still hold it on death and the company remains qualifying. This option is high risk and you could lose the amount you invest.
It is important to remember pensions and drawdown plans do not usually form part of your estate and consequently are not subject to IHT. So maximising pension contributions could be a good way to pass on more of your wealth tax efficiently.
What is BPR?
BPR – Business Property Relief, or simply Business Relief – was first introduced in 1976 to allow family businesses to be passed down through generations free of IHT.
Its scope subsequently widened and since 1996 it was made available for a range of assets, including limited companies.
This means if you buy and holds shares in such companies you could potentially pass on those shares IHT free provided that:
- the shares are held for at least two years and are still held on death
- the company still qualifies for BPR at the time of the investor’s death
You could buy as few or as many shares as you wish. There is no upper limit or allowance. Provided the above conditions are met, the whole value of the investment – be it £10,000 or £10 million – should attract 100% IHT relief.
Please note, tax benefits depend on circumstances and tax rules can change.
What companies could qualify for BPR?
Only privately owned (unquoted) companies and those listed on AIM can qualify. However, not all of them do. A key requirement is that the business must be trading – it can’t simply hold cash, investments or property.
So, for instance, a furnished holiday letting business would normally be considered a property investment business and hence be excluded from BPR. On the other hand, property development businesses could be eligible.
A company’s BPR-qualifying status may change over time and needs to be regularly monitored. Moreover, HMRC will only confirm if the shares qualify for BPR after the investor’s death, when it’s too late to do anything about it.
Should you invest in a company that doesn’t qualify for BPR, the value of your shares could be subject to IHT.
How could I benefit from BPR?
You can pick BPR-qualifying companies to invest in and put together a portfolio yourself.
However, if you don’t have the time and resources to build your own portfolio and ensure the companies are and remain qualifying for BPR, there are two main alternatives:
- IHT portfolios – investing in unquoted or AIM-listed companies
- AIM ISAs – IHT portfolios of AIM-listed companies designed to be held in an ISA