A guide to UK inheritance tax

The years where inheritance tax (IHT) applied only to the UK’s wealthiest are long behind us. Over the last 20 years, we have experienced a boom in UK property prices, which means many of us will be impacted by inheritance tax. It can be disconcerting to realise that almost half of your hard-earned money might be heading to the taxman rather than your beneficiaries. Understanding UK inheritance tax rules is a vital starting point if you don’t want to be adversely affected by it.

What is the UK inheritance tax threshold?

There is normally no inheritance tax to pay on assets within an individual’s estate if the estate is worth less than £325,000. You might have heard this referred to as the ‘nil rate band’. Anything over the £325,000 nil rate band will be subject to the standard UK inheritance tax rate of 40%.[1] However, there are a few things that alter the 40% rate.

Inheritance tax rules for married couples and charitable giving

If an individual leaves their estate to their spouse, civil partner or a charity, there is no inheritance tax applied whatsoever. You can effectively leave an unlimited amount of money to your husband or wife without inheritance tax being levied.

It’s also important to be aware that any unused nil rate band on the first death within a married couple, or civil partnership, can be transferred to the surviving spouse.[2] Although, you can only inherit double the allowance, so it won’t continue to accumulate if you are unfortunate enough to be widowed for a second time.

If charity is important to you, and you leave at least 10% of your estate to registered charities, the 40% inheritance tax charge will be reduced to 36% for the remainder of your estate.[3] This can be an effective way to reduce your inheritance tax burden whilst also making a positive impact on the world.

Inheritance tax on property

In 2017, the government introduced the ‘residence nil rate band’, which is a superb benefit for homeowners. The residence nil rate band is an additional £175,000 that can be added to your standard nil rate band when you are passing on a property to direct descendants such as children. It can only be applied to one property and the property must have been a residence of the deceased.[4]

However, when totalled, the impact on your overall inheritance tax position is significant. If you are married, or in a civil partnership and you both own a property, you can effectively pass on £1 million of assets to your direct descendants entirely free of inheritance tax. This can get a little complicated though and the rules start to alter for estates above £2 million, so it’s best to seek advice if you fall into this category.

Inheritance tax and gifting

Gifting can be a great way to reduce your inheritance tax liability. Everyone has an annual gifting allowance which means they can give away £3,000 a year without any IHT implications.[5] There is also a phenomenal wrinkle in the tax system that few people make use of effectively, known as ‘gifts out of excess income’. As long as you can evidence that you are making a gift regularly and out of earned income (that you otherwise didn’t need), you can gift an unlimited amount completely tax-free. And finally, a gift of absolutely any size will fall out of your estate after seven years, which is unusually generous compared to other tax jurisdictions. Although, do bear in mind that there are slightly different rules if the gift is made to a trust as opposed to an individual.

It’s why, if control isn’t important to you, gifting can be a great option. Before even considering gifting though (or any other methods to reduce your inheritance tax liability), do ensure you have carried out a cash flow plan with an adviser to determine that you have enough funds to meet your own needs first.

So, with the inheritance tax threshold impacting more and more people in the UK, make sure you keep an eye on all the rules and how they could apply to your estate.