What is Inheritance Tax?

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 every 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 £474,601 (The Land Registry, 2019) and in UK is £234,370 (The Land Registry, 2019).

Even with the new additional Nil rate band when a residence is passed on death to a direct descendant (which started at £100,000 in 2017/2018 and is increasing each year to £175,000 in 2020/2021 per person), 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 incur IHT).

When Bob dies in November 2020, his allowances of the nil rate band threshold (£325,000) and the additional nil rate band (£175,000 for 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 decedent. People who are single and/or those without direct decedents, 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.

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