Inheritance Tax is a tax on the estate of someone who has died. Your estate includes everything you own at the time of your death.
An estate normally includes:
- Property or land
- Money in bank accounts
- Savings and investments
- Personal belongings (such as jewellery or vehicles)
- Insurance payouts
- Certain gifts made in the years before death
After death, the Executor of the Will must value the estate by totalling any assets and subtracting any debts. Debts may include mortgages or loans. The remaining figure forms the value used for Inheritance Tax.
If the estate sits above the available tax-free limits, Inheritance Tax may apply. In some cases, no tax is due but the estate may still need reporting to HMRC.
Moreover, from April 2027, most unused pension funds and certain death benefits will fall within the scope of Inheritance Tax.
When Do You Pay Inheritance Tax?
Most people start with a tax-free threshold of £325,000. This is the nil-rate band.
If the estate remains below this amount, Inheritance Tax usually does not apply. Additionally, no tax normally applies if everything above the threshold passes to a spouse, civil partner or charity.
The standard Inheritance Tax rate is 40%, which only applies to the portion of the estate above the available threshold.
For example: An estate is worth £500,000. The tax-free threshold is £325,000. That leaves £175,000 taxable. In this case, Inheritance Tax would be 40% of £175,000 and the tax bill would be £70,000.
Can the Threshold be Higher?
Yes, in certain situations, the threshold can increase.
If you leave your home to your children or grandchildren, your tax-free limit may rise. This extra allowance is the residence nil-rate band, which can add up to £175,000. Therefore, this means you may be able to pass on up to £500,000 before Inheritance Tax applies. However, the estate usually needs to be worth less than £2 million to receive the full extra allowance, as it reduces above this level.
If a spouse or civil partner passes away without using their entire tax-free allowance, the unused portion can transfer to the surviving partner. This is the transferrable nil-rate band, which can raise the couple’s combined threshold to between £650,000 and £1 million (if they qualify for the residence nil-rate band.
Additionally, anything left to a spouse or civil partner usually passes free of Inheritance Tax.
The 7-Year Rule and Taper Relief on Gifts
Giving away assets during your lifetime can reduce the value of your estate. Many lifetime gifts become free from Inheritance Tax if you live for 7 years after making them. This is the 7-year rule.
However, tax may apply if you die within those 7 years, with the tax rate depending on when you made the gift. If you die within 3 to 4 years of making a gift, taper relief begins to apply at 20%. This reduces the amount of tax payable on the gift.
| Years | Tax Due | Taper Relief |
|---|---|---|
| 0 to 3 | 100% | No Relief |
| 3 to 4 | 80% | 20% |
| 4 to 5 | 60% | 40% |
| 5 to 6 | 40% | 60% |
| 6 to 7 | 20% | 80% |
| 7+ | 0% | Fully Exempt |
Additionally, some gifts fall outside of Inheritance Tax rules straight away:
- Up to £3,000 each tax year using the annual exemption
- Small gifts of up to £250 per person each tax year
- Wedding or civil partnership gifts (within set limits)
- Regular gifts from surplus income (if they do not affect your standard of living
- Unlimited gifts to a spouse or civil partner
- Gifts to charities
You should always keep a record of what you gave, when you gave it and who you gave it to.
Continuing to Benefit from Gifts
If you give something away but continue to benefit from it, HMRC may still treat it as part of your estate. This is a gift with reservation.
For example: You might give your house to your children but continue living there. If this happens, the property may still count as part of your estate.
To avoid this issue, you usually need to pay a full market rent and cover your share of the bills. Otherwise, the gift may not reduce your Inheritance Tax liability.
Who Pays Inheritance Tax?
It is the responsibility of the executor of the Will to pay Inheritance Tax with estate funds. They must pay the tax within 6 months of the person’s death. Interest may apply if payment is late. Funds may come from savings or cash released from bank accounts. In some cases, the estate may need to sell assets to raise the required funds.
Additionally, the executor must submit full details of the estate to HMRC to ensure the correct amount of tax is calculated and paid.
HMRC may allow payment by instalments if the estate includes property. This allows the executor to pay Inheritance Tax in instalments over 10 years, but interest may also apply.
Do Beneficiaries Pay Inheritance Tax?
Beneficiaries do not usually pay tax simply for receiving an inheritance.
In most cases, the estate pays the tax before assets pass to beneficiaries, with the executor handling this process. However, the beneficiary may need to pay Inheritance Tax on gifts over £325,000 that were made within 7 years before death.
If you live in the inherited property as your main home, you may be exempt from Capital Gains Tax. This is not the case if you decide to sell the inherited property. Alternatively, receiving rental income from an inherited property may create a Income Tax liability.
If you jointly own a property, the inherited portion my still be subject to Inheritance Tax.
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This article is for general informational purposes only and does not constitute legal or financial advice. While we aim to keep our content up to date and accurate, UK tax laws and regulations are subject to change. Please speak to an accountant or tax professional for advice tailored to your individual circumstances. Pi Accountancy accepts no responsibility for any issues arising from reliance on the information provided.