What is Inheritance Tax?
Here I am, talking about death again! This time, Estate Planning and inheritance tax (IHT).
But what is Inheritance Tax? In simple terms, IHT is a 40% tax on assets on death over the nil rate band currently £325,000. It is slightly more complicated than this as some assets (e.g. Pensions) may not qualify for IHT. In addition, there is another nil rate band called the residence nil rate band. In the very simplest terms, the RNRB gives individuals another allowance of £175,000 (from 2020/21) against their main residence as long as it is passed to a direct descendent.
Worrying Stats
A (not so) recent survey by Octopus (April 2016) found that of the people they surveyed, only 14% were aware of the current IHT threshold of £325,000 and that anything left on death in excess of this amount would be taxed at 40%.
They also found that 78% of homeowners hadn’t considered Estate Planning or don’t think that they will be affected. This is a concern as the average price of property in London is £508,000 (ONS, 2023) and in the UK is £285,000 (ONS, 2023).
Even with the new additional Nil rate band when a residence is passed on death to a direct descendant, IHT paid to 31st March 2019 was £5.38bn (HMRC, 2019).
Like the £325,000 threshold, any unused additional nil-rate band will be able to be transferred to a surviving spouse or civil partner. Therefore as per the following example, some couples could qualify for £1,000,000 IHT free*.
Example
Bob and Sheila own a house worth £750,000. They also have invested assets worth £350,000 (excluding their pensions as they don’t currently incur IHT – they will from 2027).
When Bob dies in November 2025, his allowances of the nil rate band threshold (£325,000) and the additional nil rate band (£175,000 for the property) are passed to Sheila. When Shelia dies the following January, she has:
Her own nil rate band £325,000
Bob’s nil rate band £325,000
£650,000
As she is passing the house onto their daughter, she also has:
Her own additional nil rate band £175,000
Bob’s additional nil rate band £175,000
£350,000
As their estate is worth £1,100,000, £100,000 will be liable to IHT at 40%. The estate will therefore need to pay £40,000 tax.
A voluntary Tax?
There are ways in which this tax could have been mitigated. In addition, there are plans that could have paid the liability for Bob and Sheila had they carried out estate planning. This £40,000 could potentially have been passed on to their family in full.
Even so, Bob and Sheila were lucky as they could “club” their nil rate bands together. They could also pass their property to their daughter a direct descendant. People who are single and/or those without direct descendants will also need to consider; how much tax they would be happy for their estate to pay, how this will be paid and whether they are concerned either way.
What is Inheritance Tax?
Inheritance tax is a tax on assets on death. It is sometimes called a voluntary tax because there are ways to (very legally) avoid paying it.
If you would like to find out more or if you are concerned about inheritance tax, get in touch or read my other blogs on the subject (to follow).
*There will be a tapered withdrawal of the additional nil-rate band for estates with a net value of more than £2 million. This will be at a withdrawal rate of £1 for every £2 over this threshold.