Inheritance Tax: What You Need to Know

Many of us think that Inheritance Tax won't affect us. We assume that when our loved one passes away, their entire estate and assets will be passed down to the named beneficiaries. However, if the estate meets the Inheritance Tax threshold, a fee is taken by the government before the estate can be distributed.

What is Inheritance Tax?

Inheritance Tax is a fee that is taken from an estate when somebody passes away. However, there is a valuation threshold that must be reached before the tax is charged. If the value of the assets and estate being passed down do not exceed £325,000, no tax needs to be paid. There are some exclusions and situations where the threshold can be increased, and these will be discussed later.

In most situations, when Inheritance Tax is due the funds are taken directly from the estate by the estate's executor. This fee is then paid to HM Revenue and Customs.

Does Inheritance Tax Apply to Gifts

Inheritance Tax may have to be paid on gifts given away up to 7 years before a person's passing. However, this only applies if the gifts exceed the tax threshold. Exceptions are applied based on who the gifts were given to, and their relationship to the person who passed away.

The government defines gifts as money, personal goods, land or buildings, and stocks or shares. Every year, a person can give up to £3,000 worth of gifts without them being added to the value of their estate. Gifts given to spouses or civil partners are exempt from Inheritance Tax. This also applies to gifts given to charities and political parties.

Small Gift Allowance

Any gifts up to £250 per person don't apply to the value of the estate. This is provided the £3,000 allowance has not already been used on the person receiving the gift. Birthday and Christmas gifts are also exempt from Inheritance Tax so long as they're purchased using regular income.

Wedding Gifts

Once a year, a tax free gift can be given to a friend or family member who is getting married or starting a civil partnership. The amount is based on the relationship between the two people. If the gift is for a child, up to £5,000 will be tax free. £2,500 is the threshold for grandchildren or great-grandchildren. For anyone else, the threshold is £1,000. It is possible to combine the £3,000 annual exemption with the wedding gift exemption, making it possible to give a tax free gift of £8,000 if their child is getting married.

How Much Inheritance Tax Needs to Be Paid on Gifts?

Even if somebody does exceed the threshold for the year, no tax will need to be paid on gifts unless they pass away within 7 years of giving the gift. The amount of tax that needs to be paid is based on how long ago the gift was given.

If a person passes away less than 3 years after giving a gift that exceeded the Inheritance Tax threshold, the estate would pay 40% on the item(s).

This decreases to 32% if they pass away between 3 and 4 years after giving the gift, 25% between 4 to 5 years, 16% for 5 to 6 years, finishing at 8% for 6 to 7 years.

How Do You Calculate Inheritance Tax?

Calculating Inheritance Tax can be a complex process. First, it's important to understand whether Inheritance Tax even needs to be paid on the estate. To do this, you must identify which tax threshold the estate falls under.

As previously mentioned, the base Inheritance Tax threshold is £325,000. If the value of the estate falls below this, no Inheritance Tax needs to be paid.

If the person's home is being given away to their children or grandchildren, the threshold increases to £500,000. This threshold increase can also come into effect if the home is passed on to a partner and the estate is worth less than £2 million.

If a person is married or in a civil partnership, and their estate is worth less than the threshold, any unused threshold will be added to their partner's.

The standard Inheritance Tax rate is 40%. However, it can be reduced to 36% on some assets if at least 10% of the estate's net value is left to charity.

When the applicable threshold has been identified, you will next need to investigate the deceased's debts and assets. This includes savings, investments, loans, and gifts given within the last 7 years.

After that, the estate's value must be estimated. Once that is done, if the combined value is above the Inheritance Tax threshold, the full details of the estate's value must be reported to the government. They may take several months to investigate the report and calculate the tax. This may take even longer if it is a particularly large estate.

Where Can I Find Support for Inheritance Tax?

Calculating Inheritance Tax is not a task that should be undertaken alone. It's recommended that you receive help from a professional body such as a solicitor. This will help to ensure that calculations are correct.

You can also find more information from the government website. Inheritance Tax calculators provided by services such as Which Money can also prove helpful.

If you need further support or information, read our helpful blog on Making a Will or handling Funeral Costs.

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