Inheritance Tax: How does it work and can you avoid it?

As Wills & Tax Solicitors, we get asked a lot of questions about Inheritance Tax, both by new and existing clients.

Most of the time, clients just want to know how the tax works, and whether they/their beneficiaries will have to pay it.

So, in this article, Wills & Tax Solicitor Rhiannon Stevinson aims to clear up any confusion and answer your burning Inheritance Tax questions.

What is Inheritance Tax?

Inheritance Tax is a tax that is payable when you die and is chargeable against your assets and estate.

Your estate includes all of your property, money, possessions, assets and more.

Related: How can I pass on my estate and assets when I die?

How much is Inheritance Tax?

In simple terms, Inheritance Tax isn’t payable on the first £325,000 of an estate. Anything over that number is taxed at 40%.

For example, if an estate is worth £425,000, only £100,000 of it would be taxable at 40%.

This £325,000 threshold is known as the Nil Rate Band.

An estate worth less than the Nil Rate Band (£325,000) will not incur any Inheritance Tax.

Is Inheritance Tax always 40%?

There are some situations where Inheritance Tax may be lower. For example, if you give 10% or more of the net value of your estate to charity in your Will, the Inheritance Tax rate will be reduced to 36%.

Leaving money to charity in a Will is called legacy giving and has many benefits outside of tax reductions. Read our dedicated article on legacy giving here.

What Inheritance Tax reliefs are there?

Aside from reducing the Inheritance Tax percentage, you may be able to claim additional reliefs to mitigate potential Inheritance Tax.

This could be possible where the deceased owned a property, or share of a property, which is left to their direct descendants (i.e. children), as the Residence Nil Rate Band allowance (RNRB) may apply.

The current Residence Nil Rate Band allowance is £175,000. The estate within this allowance is taxed at the rate of 0%.

If your spouse has not used all of their Nil Rate Band allowance and/or their Residence Nil Rate Band allowance when they passed away, this can be transferred to your estate.

How do you apply for RNRB?

If you meet the requirements (i.e. the property was lived in by the deceased at some point during their lifetime and you’re a direct descendant) your Executors can apply for the Residence Nil Rate Band by filling out the Government form.

There are also other factors that affect the ability to claim the Residence Nil Rate Band, so it is worth speaking with one of our experts to check your Inheritance Tax position. You can call us on 01202 499255, or fill out the form at the top of this page, for a free initial chat.

Do I have to inform HMRC if I inherit money?

You don’t need to inform HMRC when you inherit money as any tax will be paid by the Executor of the estate.

However, if you go on to generate an income or gain from the inherited assets, for example you gain interest/profit from an asset by selling it, you will need to report this and there could be tax due.

What is exempt from Inheritance Tax?

Inheritance Tax is usually not payable if either:

• the value of an estate is below the £325,000 ‘Nil Rate Band Allowance; and/or
• everything is left to a spouse, civil partner or charity.

Related: What happens to a Will after divorce?

Can I avoid Inheritance Tax?

Aside from the above methods, there aren’t really any other ways to ‘avoid’ Inheritance Tax entirely. You can, however, reduce the Inheritance Tax you pay in a variety of ways:

Gifts

Making gifts during your lifetime can help with your Inheritance Tax position. Speak with one of our experts to discuss this further before taxing any steps.

‘Large’ gifts of over £3,000 that are made more than seven years before your death are exempt from Inheritance Tax, but, if you were to pass away within those seven years, Inheritance Tax could be payable.

To avoid this issue, you can give away up to £3,000 per year without the seven-year rule applying. And, if you haven’t gifted in the previous year, you can carry forward your previous year’s annual gift exemption and gift up to £6,000.

Marriage Allowance Gifts

In addition to your annual allowance, you can also gift money to family who are getting married. You can gift up to:

• £5,000 to your child
• £2,500 to your grandchild/great-grandchild
• £1,000 to any other person

Marriage allowance can be used in addition to an annual gift to maximise your exemption.

Trusts

Trusts are always a flexible option for making gifts, particularly if you want to control your assets after they are ‘gifted’.

The seven-year rule still applies to trusts though, and to save Inheritance Tax, neither you, as the trust creator, or your spouse can benefit from the assets put into it.

Pensions

If you were to pass away before 75, passing on your pension pot would be tax free. If you were to pass away after 75, your beneficiaries will be charged at their marginal rate which, in most cases, would only be 20%, as opposed to the usual 40% on inheritance.

Aside from your pension, a financial advisor may be able to help you in identifying investment options and additional relief exemptions to help reduce the tax burden.

And, as we’ve already mentioned throughout this article, Inheritance Tax can be reduced by:

• Making use of Gifting Allowances
• Applying for the Residence Nil Rate Band

Do you pay Inheritance Tax if you inherit a business?

Your beneficiary may have to pay Inheritance Tax when inheriting your business if your estate is taxable.

However, beneficiaries may be able to claim business property relief. Find out more here.

Specialist Inheritance Tax Solicitors

It is essential to regularly review your Will and Inheritance Tax position.

The Inheritance Tax rule is rumoured to be changing as part of the October 2024 budget. To be kept up to date with any changes, you can sign up to our Wills & Tax newsletter here.

At Frettens, we would be happy to have a conversation with you to discuss your individual circumstances and assist you in reviewing your Inheritance Tax position.

We can also provide advice for all other areas of Wills & Tax law, including advice on how to write your Will, what to include, and more.

Alternatively, you may wish to contest a Will. Find out more here.

Call us on 01202 499255, or fill out the form at the top of this page, for a free initial appointment.