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Inheritance tax: thresholds, rates and who pays

By Ian Robinson

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Inheritance tax: thresholds, rates and who pays

Inheritance tax (IHT) is a tax on money or possessions you leave behind when you die. Watch our 2 minute video to find out how it works.

Video transcript

If your estate is worth more than 325,000 pounds when you die, your heirs will have to pay inheritance tax on everything over that amount. But they'll pay nothing, if your estate totals less than that. Your estate includes your property, savings, and any other assets you pass on after debts and funeral expenses have been paid.

And the tax rate is 40%. But if your estate is entirely inherited by your spouse or civil partner, they don't have to pay any inheritance tax. Anything after the 325,000 pound figure is called the nil-rate band. And the figure is attached to the estate of the person who dies, rather than to the people who inherit.

The nil-rate band can be passed on to a surviving spouse or civil partner. And they can add it to their own nil-rate band. Meaning that when they die, they can leave an estate worth 650,000 pounds that's free of inheritance tax. So what happens if you give away money and property while you're still alive? You can make gifts of up to 3000 pounds in any tax year, without worrying about inheritance tax.

And you can give far more tax free, as long as you live for seven years after you've made the gift. But if you die within seven years of making it, HMRC will treat it as part of your estate. So how much tax will be due? Inheritance tax is due only on anything above the 325,000 pound threshold.

It's normally 40%, but it's cut to 36%, if you give away a tenth of your estate to charity. Lastly, there's something else that's worth knowing. From 2017, there's going to be an extra allowance covering the value of your main home, starting at 100,000 pounds but rising to 175,000 pounds per person by 2020.

Combined with a normal nil-rate band, it means an individual will be able to leave 500,000 pounds, and a couple up to a million, without their estate being subject to inheritance tax at all. To find more about inheritance tax see which.co.uk/iht [SOUND]

 

Inheritance tax rules and 'nil-rate band' explained

If you plan to pass on assets or money after you die, your heirs could face a big tax bill when they receive it. 

But a certain amount can be passed on inheritance tax-free; this tax-free allowance is officially called the 'nil-rate band'.

Everyone in the 2017-18 tax year has a tax-free inheritance tax allowance of £325,000. The allowance has remained the same since 2010-11, and will stay frozen until at least 2019. 

If you pass on your home to your children - including adopted, foster or stepchildren - or your grandchildren, your allowance increases to £425,000. 

You can also give away a certain amount of your money during your lifetime, tax-free and without it counting towards your estate. 

Your estate is defined as your property, savings and other assets after debts and funeral expenses.

  • The Which? Money Helpline offers independent guidance on all types of tax issues, including inheritance tax. If you're not a Which? member, and you'd like to get unlimited access to our Money Helpline experts, you can try Which? Money for two months for £1.

Inheritance tax thresholds and rates 2017/18

The standard inheritance tax rate is 40% of anything over the £325,000 threshold. 

For example, if you leave behind an estate worth £500,000 the tax bill will be £70,000 (40% on £175,000 - the difference between £500,000 and £325,000). 

However if you're passing on a home, or if you're married or in a civil partnership, you may be able to leave more than this before paying tax. 

Inheritance tax rule changes for property 2017/18

From April 2017 you can pay less inheritance tax if you're leaving property to a family member

The new transferable main residence allowance allows you to pass on an extra £100,000 from April 2017, rising to £175,000 by April 2020. 

Find out more: read our inheritance tax property guide for everything on the new rules

Inheritance tax rules for married couples and civil partners

Married couples and civil partners are allowed to pass their possessions and assets to each other tax-free.

The surviving partner is allowed to use both tax-free allowances. This is providing one wasn’t used at the first death, by giving away a big chunk of money in the first will, which could diminish or use all of the inheritance tax allowance.

This can effectively doubles the amount the surviving partner can leave behind tax-free without the need for special tax planning.

A married couple or civil partnership can pass on up to £650,000 in 2017-18, or £850,000 if your estate includes your home. 

However, some people whose partner died before 21 March 1972 will be caught by a loophole which means they don't get a 'double allowance'. 

Find out more: inheritance tax for married couples and civil partners: see the benefits to your inheritance tax bill

Gifts and other ways to avoid paying inheritance tax

Some gifts are always tax-free. These include gifts between spouses and civil partners, and gifts to charities. 

There are some others that are potentially tax free (known as potentially exempt transfers or PETs). The key here is when they are made. 

Generally, as long as a gift is made more than seven years before your death to an individual and not to a business or a trust, you won't pay tax on them. 

If you do die within these seven years, the gift will be taxed. 

Find out more: tax-free gifts and PETs explained - how to avoid inheritance tax

There are other ways to avoid inheritance tax too - including putting your life insurance policy under trust, or having a deed of variation in your will. 

Find out more: ways to avoid inheritance tax including equity release and insurance policies

Who pays the inheritance tax bill?

Inheritance tax that becomes due on money or possessions passed on when you die is usually paid from your estate. Basically, your estate is made up of everything you own, minus debts such as your mortgage and expenses such as funeral expenses.

However, if the tax is due on gifts you made during the last seven years before your death, the people who received the gifts must pay the tax due.

If they can't or will not pay, the amount due then comes out of your estate.

Your heirs must pay inheritance tax by the end of the sixth month after the person died. An inheritance tax reference number from HMRC is needed first, and should be applied for at least 3 weeks before a payment needs to be made. 

Find out more: our probate guides explain the legal process for dealing with the estate of someone who has died

  • Last updated: June 2017
  • Updated by: Tom Wilson
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