Article by Naomi Webb
It’s fair to say that no taxes are overly popular, yet there is a particular dislike reserved for inheritance tax – the most hated of them all. This is a tax that takes a slice of the wealth left behind by some people when they die to go back into the coffers of the state. Whether you think that is fair is up to you but it exists, and how much do we actually know about it?
The truth is, other than a passing knowledge of its existence, very few of us even knows the basics.
Here are your key questions answered:
Who must pay inheritance tax?
Very few estates actually have to pay inheritance tax. The figure for 2016/17 is set to stand at about eight per cent – or just over 40,000. Yet this is a tax that is affecting an ever-larger number of people. For the last tax year, it saw about £4.6 billion paid to the exchequer, almost exactly double the figure for 2009/10.
Essentially everyone who dies benefits from a tax-free allowance or ‘nil rate band’ on their estate which, as of this financial year, is £325,000. Any wealth under that band can be handed over tax-free.
Any wealth over and above this is taxed at 40 per cent. So, as demonstrated here, if someone leaves an estate worth £450,000 then £50,000 of inheritance tax must be paid – which is 40 per cent of the £125,000 over the ‘allowance’ that they have left behind.
On top of that, married couples or those in civil partnerships can hand over their wealth to their spouse tax-free when they die, alongside their ‘unused’ allowance – meaning that couples can benefit from a £650,000 joint nil rate band.
If someone dies outside the UK then it is only their UK assets – homes, bank accounts etc – that they must pay this tax on.
When must you pay?
The tax must be paid – by the executor of the will or administer of the estate typically – within six months of someone’s death. If this deadline isn’t met then interest will be added onto the cost.
Executors can ask for an extension to this period if they need extra time to sell a house, for example, and this can be paid in instalments – albeit with interest.
Some people take out a life insurance policy with the distinct aim of paying this tax when they die.
What if I give money away instead?
Many people may wish to donate money or possessions to their children and grandchildren before they die. It’s important to be aware of the rules surrounding this as these could be added to the value of the estate that you leave behind.
These are known as ‘gifts’. It’s important to realise that this isn’t about gifts in the Christmas present or birthday present for partners. This relates to money, property or other possessions. Be careful with property too. If you sell a home at a discounted rate to a relative, the difference between its market value and the price you sold it for is seen as a ‘gift’.
You are allowed to pass on £3,000 worth of gifts every tax year without them counting to the value of your estate, however. And you can also give away wedding gifts (£1,000 for anyone, £2,500 for a grandchild, £5,000 for a child) and money to charities, political parties or even towards the living costs of a relative as well as small gifts of up to £250 (as long as you’ve not already used a different exemption up on the recipient!).
Gifts beyond that count towards the cost of your estate and would be eligible for inheritance tax if you die within seven years of making them. There’s no denying that this is a tricky policy to get your head around and it really does pay, literally, to obtain impartial financial advice if you are unsure about the leaving of gifts.
How are the rules changing?
The policy in this area is not standing still – there are big changes that you need to be aware about.
In a bid to prevent the steady rise in the number of people forced to pay inheritance tax – arising largely from increased property prices – new rules are being introduced from 2017.
These will create a ‘main residence’ element to inheritance tax. Initially this will add £100,000 each to the allowance for people leaving a property to a child or grandchild, rising to £175,000 by 2020. The cumulative effect of this will be that couples can leave £1 million tax-free if they are handing down a home to a direct descendant.
Note: this post is for general information only. It is always best to take independent professional advice prior to making major financial decisions.