With that in mind, it’s a good idea to become familiar with the rules surrounding the tax. It’s not the easiest thing to get your head around, granted, but it is important if you don’t want to hit with a hefty bill out of the blue at a time when you’re likely to have a lot to cope with.
First things first, what is inheritance tax?
This involves the state taking a share of the wealth left behind by some people when they die. It’s fair to say it’s not particularly popular – in fact some say it is the most hated tax of them all.
In truth, very few estates actually need to pay inheritance tax. The BBC reported that the number of families that will pay in 2016/17 is expected to be about eight per cent.
That might sound low but it will still mean that more than 40,000 estates end up paying something.
The number of people needing to pay is also rising – as is the amount of money this delivers to the Treasury. In 2015/16 about £4.6 billion of inheritance tax was paid but that was almost double the amount paid six years before, in 2009/10.
The estate of anyone who dies benefits from a tax-free allowance that is called a ‘nil rate band’. This allowance currently stands at £325,000 and any wealth that falls under that figure can be passed on without the need for inheritance tax.
Anything over and above this is taxed at 40 per cent.
As an example, if you left £500,000 then you’d pay nothing on the first £325,000 and 40 per cent on the remaining £175,000 – which is £70,000.
Anyone in a civil partnership or who is married is able to pass their estate on to their spouse when they die tax-free, as well as their ‘unused’ allowance. That, in effect, means that couples get a £650,000 joint ‘nil rate band’.
It’s also worth noting that if someone dies outside of the UK then it is only their UK assets that they have to pay the tax on, meaning any homes or bank accounts in the country.
It’s also worth noting that this tax needs to be paid within six months of the death of the person in question.
That might seem like a long time but it can soon pass, especially if you need to go through the process of probate. To read more about probate, check out our guide to what it is and what it means to you.
If the deadline isn’t met then you could find that interest is added to the amount that needs to be paid.
The tax should normally be paid by the executor of the will or the administrator of the estate.
There are also a number of other rules surrounding inheritance tax that you should be aware of.
Perhaps most notably are the rules surrounding ‘gifts’. This specifically refers to money, property or possessions that people might pass on to their family before they die (not gifts in the ‘presents under the Christmas tree’ sense).
You should be doubly careful when it comes to property. If you sell a house to a relative at a knock-down rate, for example, then the difference between the sale price and the market value will be seen as a ‘gift’.
So, what impact do ‘gifts’ have on inheritance tax?
Well, as with the tax itself, you do have an ‘allowance’ here too. People can pass on £3,000 worth of gifts every tax year without them impacting upon the value of their estate as a whole.
On top of that, people can also give:
That’s a fairly long list and covers quite a few of the common reasons to leave a ‘gift’.
However, if you do leave a gift that falls outside of those exemptions then this would count towards the cost of an estate. Importantly, it could be eligible for inheritance tax for up to seven years.
Gifts made within three years of a person’s death are liable for inheritance tax at a rate of 40%. Beyond that, there is a sliding scale until you reach seven years. So gifts left three to four years before someone’s death are taxed at 32%, four to five years at 24%, five to six years at 16%, six to seven years at 8% and beyond that nothing.
Again, this is only if they fall outside the limits and exemptions and if the person’s estate requires them to pay inheritance tax. Clearly this can be difficult to calculate so you should always look to employ the services of a trained financial advisor to help make sure you handle this accurately.
New rules will change the way inheritance tax is calculated and paid from 2017. These are being introduced to reflect the fact that property prices have increased to a level that means more and more people do have to pay some inheritance tax.
The changes add in a ‘main residence’ element to inheritance tax.
This adds £100,000 each to the allowance for people leaving a property to a child or grandchild, rising to £175,000 each by 2020.
Eventually this means that couples will be able to leave £1 million tax-free, provided they pass a property down to a direct descendant.
The rules around inheritance tax are clearly not set in stone. It is within the power of any Government to alter the allowance levels or any of the other details. This means it is well worth keeping an eye out for the budget statements made by the Chancellor of the Exchequer and making a note of any changes they contain.