Navigating the world of inheritance tax can be a daunting prospect, but with a clear understanding of the key rules and exemptions, you can effectively plan for the future and ensure your loved ones are protected. This comprehensive beginner's guide to UK inheritance tax will demystify the process, from what's included in your estate to how tax-free allowances can be transferred to a surviving spouse.
What is UK Inheritance Tax?
Inheritance Tax (IHT) is a tax on the estate of a person who has died. The estate includes all of their property, possessions, and money. It is a one-off tax levied on the total value of the estate above a certain threshold, known as the Nil-Rate Band (NRB).
While it's often perceived as a tax that only affects the very wealthy, rising property prices and frozen thresholds mean more and more families are finding themselves liable for IHT. Understanding the rules is therefore a crucial part of financial planning for many people in the UK.
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What is Included in Your Estate?
When calculating the value of an estate for inheritance tax purposes, you need to consider all assets and subtract any debts. This includes:
- Property and Land: This is often the largest single asset in an estate. It includes your main home, holiday homes, and any land you own.
- Savings and Investments: This covers everything from cash in bank accounts and ISAs to stocks, shares, and bonds.
- Personal Possessions: Valuables like jewellery, antiques, art, and vehicles are all part of the estate.
- Life Insurance Policies: The proceeds of a life insurance policy are included in the estate unless the policy has been written "in trust."
- Gifts: Certain gifts you made during your lifetime may also be included in the calculation, particularly those made within the seven years before your death.
What is Excluded or Exempt from Inheritance Tax?
There are several important exemptions and reliefs that can significantly reduce or eliminate an Inheritance Tax bill.
- Spousal Exemption: Any assets left to your legal spouse or civil partner are completely exempt from Inheritance Tax, regardless of the value.
- Charity Exemption: Gifts left to a UK registered charity are also fully exempt. Leaving 10% or more of your net estate to charity can even reduce the IHT rate on the rest of your estate from 40% to 36%.
- Annual Exemption: You can give away up to £3,000 in gifts each tax year without them being added to the value of your estate. This is known as your annual exemption. You can also carry any unused allowance forward to the next tax year, but only for one year.
- Small Gift Allowance: You can make unlimited gifts of up to £250 per person per tax year, as long as you haven't used another allowance on the same person.
- Wedding Gifts: There are specific exemptions for wedding or civil partnership gifts. You can give up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else.
- Gifts from Normal Income: Regular gifts made from your surplus income, which don't affect your standard of living, can also be exempt.
How is UK Inheritance Tax Calculated?
The process for calculating inheritance tax is as follows:
- Calculate the value of the total estate: This involves adding up all assets (property, savings, investments, etc.) and deducting any debts (mortgage, loans, funeral expenses).
- Apply exemptions and reliefs: Subtract any assets that are exempt, such as gifts to a spouse or charity.
- Determine the taxable portion: This is the net value of the estate after exemptions.
- Subtract the Nil-Rate Band (NRB): The standard NRB is £325,000 per individual. The value of the estate up to this threshold is taxed at 0%.
- Subtract the Residence Nil-Rate Band (RNRB): If you are leaving your home to a direct descendant (such as a child or grandchild), you may be able to claim an additional RNRB of up to £175,000. This can increase an individual's total tax-free allowance to £500,000.
- Calculate the tax due: The remaining value of the estate above these thresholds is usually taxed at a rate of 40%.
Example Calculation:
An individual dies with an estate worth £600,000. They have no spouse and no exemptions apply.
- Total estate value: £600,000
- Subtract NRB: -£325,000
- Taxable amount: £275,000
- Inheritance Tax due: 40% of £275,000 = £110,000
Use our calculator to see how different values impact your tax bill.
The 7-Year Rule and Potentially Exempt Transfers (PETs)
Gifts made during your lifetime can be complicated. If you give a gift but die within seven years, it may be included in the calculation of your estate. These are known as Potentially Exempt Transfers (PETs).
- If you live for 7 years or more: The gift is fully exempt from IHT.
- If you die within 7 years: The gift becomes a "chargeable transfer." If the total value of gifts made in the 7 years before your death exceeds the NRB (£325,000), the recipient may have to pay tax on it.
A system called Taper Relief can reduce the IHT rate on gifts made between three and seven years before death:
Years Between Gift and Death |
IHT Rate on the Gift |
Less than 3 years |
40% |
3 to 4 years |
32% |
4 to 5 years |
24% |
5 to 6 years |
16% |
6 to 7 years |
8% |
7 or more |
0% |
Transferring Inheritance Tax Allowances to a Surviving Partner
This is one of the most important aspects of UK inheritance tax for married couples and civil partners.
- Unlimited Spousal Exemption: When the first spouse dies, any assets they leave to the surviving partner are completely exempt from IHT.
- Transferable Nil-Rate Band (NRB): The unused portion of the first partner's NRB can be transferred to the surviving partner.
- Transferable Residence Nil-Rate Band (RNRB): Similarly, the unused RNRB can also be transferred.
What happens when the surviving partner dies?
When the second partner passes away, their estate can benefit from both their own NRB and RNRB, plus the unused portions of their late partner's allowances. This can effectively double the tax-free thresholds.
- Combined NRB: The surviving partner's NRB can increase from £325,000 to up to £650,000.
- Combined RNRB: The RNRB can also be transferred, potentially creating a combined allowance of up to £1 million for a couple who leave their home to their direct descendants.
To claim the transferable allowances, the executors of the surviving partner's estate must apply to HMRC. This can be done regardless of how long ago the first partner died.
Calculate your combined tax-free allowances and potential tax liability.
Other Useful Details and Key Takeaways
- Paying the Tax: IHT is typically due within six months of the end of the month in which the death occurred. Interest is charged on late payments.
- Estate Valuation: The executor or administrator of the estate is responsible for valuing all assets and reporting them to HMRC.
- Seeking Professional Advice: The rules surrounding IHT can be complex, and getting professional advice from a financial advisor or a solicitor specialising in estate planning is highly recommended.
- Forward Planning: The best way to mitigate inheritance tax is to plan well in advance. This includes writing a will, understanding all available exemptions and reliefs, and considering lifetime giving.