What do I need to know about Inheritance Tax?

When someone dies and leaves an estate behind, any tax paid on the value of it is called Inheritance Tax. The rules around it are quite complex though, and it can be tricky to know what to do for the best. In this guide, we’ll explain what it all means and things you can do to help your nearest and dearest avoid paying any Inheritance Tax (legally, of course) when you’re no longer here.

What things is Inheritance Tax paid on?

Any money in a deceased person’s bank accounts, their pension fund and investments, along with physical possessions, like houses, jewellery, furniture and cars are all classed as someone’s estate, and will possibly be liable for Inheritance Tax.

You also need to include any life insurance or other lump sum benefits paid out at the person’s death. However, charity contributions and any debts, both unsecured and secured, don’t need to be included. If an asset was owned jointly (like a house, for example) or by lots of different people, you can divide the value by the relevant number.

What is the Inheritance Tax rate?

Currently, it’s 40% on anything above £325,000 (tax is only paid on any part of an estate above this amount). If an estate is worth less than that, there’s no tax to pay. A rate of 36% is also payable in some circumstances if 10% or more of the net value (follow the steps mentioned earlier to find this number) of an estate is left to charity.

Are there any exemptions?

Yes. Anything you ‘gift’ to a spouse or partner while you’re alive is exempt. These include money, property or a physical gift. If you sell something for less than it’s worth to someone, the amount of the difference between the loss and the actual value also counts as a gift.

Gifts of up to £3,000 can be given away every year as Christmas or birthday presents, for example, and won’t be counted towards an estate. Wedding or civil ceremony gifts of up to £1,000 per person or £2,500 for a grandchild or great-grandchild, and £5,000 for a child are also exempt.

Bigger ticket items

If you gift a large item to someone, they’ll need to own it for seven years before you die to avoid paying Inheritance Tax. The amount reduces on a sliding scale before that, which you can see below.

Homes can be passed on to spouses and civil partners without Inheritance Tax having to be paid. If you want to leave it to any children or grandchildren, the threshold increases to £475,000. This is also the case if your estate is valued at less than £2million.

Other rules around homes

• If you give your home away to someone other than a spouse or civil partner and live for seven years after that, there’ll be zero Inheritance Tax to pay
• To keep living in the property, you must pay rent to the new owners, pay your share of the bills and remain there for seven years
• If you give away a part of your home or the new owners live there with you, you don’t need to pay rent

Just remember the allowances and seven-year period when thinking about property and gifts to people. It’s also worth noting that HMRC have to be told about the value of any estate, even if it’s below £325,000.

Tax treatment varies according to individual circumstance and is subject to change.

Please note that the Financial Conduct Authority (FCA) does not regulate estate planning.