If you are inheriting assets from a loved one, you need to know about the inheritance tax threshold.
Similarly, when writing a will, it’s worth keeping the rules around the inheritance tax threshold in mind.
This article will cover everything you need to know about the inheritance tax threshold and how it could affect you.
Here’s a summary of what we’ll cover:
- When someone dies there may be taxes to pay if they have assets above the inheritance tax threshold.
- The current UK threshold is £325,000 (2023/24), and anything above this is taxed at a rate of 40%.
- Those liable to pay inheritance tax will have taxes paid for them by the executor of the will.
- There are a number of ways to legally reduce or avoid inheritance tax, that are worth knowing.
What is the inheritance tax threshold?
The inheritance tax threshold, also known as nil rate band, is the amount up to which no tax is paid on inheritance.
Between 6 April 2009 and 5 April 2028 the inheritance tax threshold is set at £325,000.
This means that if your estate is worth less than £325,000 threshold, there will not be any tax to pay.
What is the inheritance tax rate?
Any money, possessions or other assets that go over the inheritance tax threshold of £325,000 are taxed at 40%.
The tax is based on the value of their estate, including property, money and possessions.
As an example, an estate worth £500,000 sees inheritance tax on the £175,000 that exceeds the inheritance tax threshold (although see detail regarding property below).
So the Inheritance tax charged will be 40% of £175,000 (£500,000 minus £325,000) = £70,000.
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What is affected by the inheritance tax threshold?
Property
If you own a property you can choose to leave it all to your spouse or civil partner who won’t have to pay inheritance tax.
Giving your home away to your children or grandchildren increases your threshold to £500,000 due to property allowance.
If you were to combine both parents’ allowance, their children could inherit up to £1 million tax free.
Remember, if you inherit property from a loved one, you must notify HMRC and pay related taxes if you get an income from it.
Money
When a loved one dies, the value of their estate is used to pay funeral costs and any outstanding debts.
If they didn’t own a property, the value of their estate is in savings and investments.
Understanding the value of an inherited estate
To find out if there’s inheritance tax to pay, you need to estimate the value of the estate and report it to HMRC.
The net value of the estate is what will be taxed.
This is the total value of their assets, including property and possessions, minus any debts.
Who pays inheritance tax?
After someone dies, funds from their estate are used to pay inheritance tax to HMRC if any is due.
If there is a will, payments will be organised by the executor of the estate, who pays taxes before money and assets are distributed.
Inheritance tax is paid by direct transfer or selling property equity and possessions to meet the value owed.
This means that the beneficiaries do not normally pay direct tax on things they inherit.
Who is affected by the inheritance tax threshold?
There are a number of situations where the inheritance tax threshold changes.
This can depend on your legal relationship with the person who has died.
The next section will look at how different relations are affected by the income tax threshold.
Spouses or civil partners
Spouses and civil partners have a beneficial status when it comes to the inheritance tax threshold.
They will never have to pay inheritance tax on assets left to them, no matter how much they amount to.
Plus, when they then die, they’ll have inherited your unused threshold, potentially allowing them to pass on up to £650,000 tax-free.
Children
This category includes children, adopted, fostered or stepchildren as well as grandchildren.
If you leave your home to your children or grandchildren in your will, property allowances will increase your tax-free threshold to £500,000.
Recipients of gifts
You may want to give away some of your assets, including money and possessions.
This is allowed, but bear in mind that the recipients might have to pay inheritance tax.
They would be taxed on the gifts if you give away more than £325,000 and die within 7 years.
This is to avoid the deprivation of assets where you give away money and items of value to avoid paying tax.
What if assets are below the inheritance tax threshold?
Not everyone will have to have to pay the 40% inheritance tax rate.
If the total value is less than the inheritance tax threshold of £325,000 the tax rate is 0%.
So there won’t be any inheritance tax to pay if the value of your estate is below the inheritance tax threshold.
Even if the estate’s value is below the threshold, you may still need to report your inheritance gains.
This is important if you receive any means-tested financial benefits for elderly or local authority funding for care.
Is it possible to reduce the amount of inheritance tax paid?
In short, the answer is yes.
There are a number of legal ways to reduce how much inheritance tax you owe.
This is done by choosing how and to whom your estate will be passed on to after you die.
For example, there are rules around the inheritance tax threshold and property, as well as life insurance.
Assets that exceed the inheritance tax threshold
For assets that exceed £325,000, you can avoid paying inheritance tax by leaving property and possessions to your spouse or civil partner.
Subsequently, when they die, they can then pass on double the amount tax-free to your children.
Some people also choose to put their money in a life insurance policy or trust, which can be accessed tax-free.
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Inheritance tax threshold and charity
If the value of the estate exceeds the inheritance tax threshold of £325,000, a 40% tax will apply to anything above this.
However, if 10% of the total estate has been left to a charity an inheritance tax rate of 36% will typically apply.
The same rate of 36% applies if at least 10% is left to a community amateur sports club.
Doing this means that you won’t pay tax on the value that exceeds the inheritance tax threshold.
Life insurance and inheritance tax threshold
Most life insurance policies count as part of the estate value unless the policy is written in trust.
It must be specified that the policy is in trust otherwise you’ll be taxed on the money it holds.
Money from your insurance goes straight to your beneficiaries and won’t count towards your inheritance tax threshold.
Inheritance tax threshold: Key advice
- If someone dies and leaves you an inheritance such as money or property, you are required to report it.
- Be mindful that any money you inherit becomes savings, which could affect you if you receive state benefits.
- There are ways around paying large inheritance tax costs if your assets are managed well.
- Use an expert advisor to help you manage your assets and write a will.
- Mismanagement of your assets, while you are alive, could cause your loved ones financial stress when you die.
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