A guide to Inheritance Tax

In this article, our experienced team of financial advisers at PIL Southampton talks through everything you need to know relating to Inheritance Tax. 

It can be a complicated area, and we advise you to seek professional advice from an independent financial expert like the team at PIL Southampton. We are helping people with their estate planning every day and are familiar with all the regulations and any possible options for reducing your Inheritance Tax liability. 

What is Inheritance Tax? 

Inheritance Tax is a tax levied when someone dies, if their estate consists of more than £325,000 in combined assets – property, money and possessions.

If the estate is below the £325,000 threshold, known as the ‘Nil Rate Band’, there will be no Inheritance Tax to pay, however you may still need to send full details of the estate to the government. See ‘Valuing the estate’ further in this article.

How much is Inheritance Tax? 

The rate of Inheritance Tax at the time of writing is 40%, which applies to the taxable amount of the estate. For example, with the threshold currently being £325,000, if the estate is valued at £600,000 then Inheritance Tax will be due on £275,000.

No Inheritance Tax is payable above the threshold if your estate is bequeathed to your spouse, civil partner, or to an exempt beneficiary like a charity or community amateur sports club.

Passing on a home 

There is no Inheritance Tax to pay on a home you pass on to your spouse or civil partner when you die. However much it is worth, it is not calculated as part of the estate.

If you choose to leave your home to someone else in your will, it counts towards the value of the estate.

If you own your home (or a share in it) your tax-free threshold can increase from £325,000 to £500,000 if you leave it to your children or grandchildren, and if your estate is worth less than £2 million.

Note: ‘Children’ includes stepchildren, adopted or fostered children, but the tax threshold increase doesn’t apply to homes passed on to siblings, nephews and nieces.

You also have the option of passing on your home before you die, without Inheritance Tax being applicable, if you gift the property, move out and live for at least seven years. If you want to pass on your home with no Inheritance Tax payable but continue to live in it, you will need to pay rent to the new owner at the local market rate, pay your share of bills and live there for at least seven years. But remember, someone else now owns your home!

Note: You don’t have to pay rent and contribute to bills if you have only given away part of the property and if the new owners are also living there with you.

If you don’t meet these criteria, then passing on your home will count as a ‘gift with reservation’ and will be included as part of the value of your estate when you die.

Passing on your home will also be defined as a gift if you die within seven years of transferring ownership, at which point the seven-year rule would apply.

One other point to note is that tapered withdrawal of the home allowance applies if the overall value of the estate is above £2 million.

Married couples and civil partners can pass on unused threshold 

The Nil Rate Band is staying fixed at £325,000 until 2026; however it may be increased if you are widowed or a surviving civil partner. 

This is because couples can transfer to their surviving partner any unused Nil Rate Band, which could double the amount of Nil Rate Band available to £650,000.

Valuing the estate 

Before you report the value of the deceased’s estate, make sure you have checked the details you need to send, so that you complete the correct forms.

Note: You may have to pay a financial penalty if you give inaccurate information.

Valuing the estate will involve listing all the deceased’s assets, working out their value at the date they died, and deducting all debts and liabilities.

HMRC may ask to see records proving the valuation, i.e. an estate agent’s valuation of the property, up to 20 years after Inheritance Tax is paid.

Assets you’ll need to incorporate in the estate’s valuation will include:

• Jointly owned assets
• Property and land
• Investments, stocks and shares
• Money in bank accounts
• Jewellery
• Cars and other mobile assets (i.e. boats or caravans)
• Payouts from insurance policies
• Gifts given within seven years of the person’s death, possibly 14 years if certain gifts have been made to trusts

From April 2027, most death benefits from pensions and unused pension pots will also be counted as part of the value of an estate.

You can use the government’s online checker tool to find out if Inheritance Tax is due.

Even if no tax is due, you will need to send full details of the estate if any of the following applies to the person who died:

• gave away over £250,000 in the seven years before they died
• gave gifts then continued to benefit from them in the seven years before they died
• left an estate worth more than £3 million
• was ‘deemed domiciled’ in the UK
• had foreign assets worth more than £100,000
• was living permanently outside the UK when they died but had previously lived in the UK
• had a life insurance policy that paid out to someone other than their spouse or civil partner and also had an annuity
• had increased the value of a lump sum from a personal pension to be paid after their death, while they were terminally ill or in poor health
• had agreed that property they’d given away during their lifetime would be part of their estate rather than pay a pre-owned asset charge

If the estate includes trusts, you will need to complete a full account if the deceased gave gifts that were paid into trusts, or if they held assets worth over £250,000 in trust, or if they held more than one trust. 

You will also need to complete a full account if a trust worth more than £1 million was passed on to a surviving spouse, civil partner or charity, or if there was at least £250,000 remaining after the amount bequeathed to the surviving spouse, civil partner or charity has been deducted. 

You do NOT have to give full details of an estate’s value if all of the following statements are true:

• the estate counts as an ‘excepted estate’
• there’s no Inheritance Tax to pay
• you’ve checked that none of the reasons under when you need to send full details of the estate’s value even if no tax is due apply

Most estates are excepted estates. An estate is usually an excepted estate if any of the following apply:

• its value is below the current Inheritance Tax threshold
• the estate is worth £650,000 or less and any unused threshold is being transferred from a spouse or civil partner who died first
• the deceased left everything to a spouse or civil partner living in the UK or to a qualifying charity and the estate is worth less than £3 million (search the charity register for registered UK charities)
• the deceased was living permanently outside the UK (a ‘foreign domiciliary’) when they died and the value of their UK assets is under £150,000

Who pays Inheritance Tax? 

The person handling the deceased person’s estate, known as the ‘executor’, is responsible for carrying out the wishes stipulated in a will, and paying any due Inheritance Tax to HM Revenue and Customs (HMRC), using funds from the deceased’s estate.

The will stipulates the executor/s so, if there is no will in place and the person dies intestate, the administrator of the estate will be responsible for processing any Inheritance Tax payment that’s due.

Although Inheritance Tax can be paid from estate funds or monies raised from sale of assets, usually all or some of any Inheritance Tax due is paid directly from the deceased bank or building society account – this is called the Direct Payment Scheme ‘DPS’.

When does Inheritance Tax need to be paid? 

If it’s not paid within six months of the death, HMRC will start charging interest on the monies due. Executors can choose to pay tax on assets like properties in instalments over a 10-year period, but this will still incur interest.

It’s advisable to pay some Inheritance Tax within the first six months of the death, even if the estate hasn’t been officially valued yet. This is known as ‘payment on account’ and it should reduce the amount of interest that could be charged in the future.

How can I reduce the amount of tax paid? 

There are ways you can potentially reduce the amount of Inheritance Tax that will be payable on your estate. These options include leaving your estate to a spouse/civil partner, regularly giving away up to £3,000 per annum in the form of gifts, putting your assets into a trust for your heirs or leaving a legacy to charity.

At the time of writing, assets in pensions are free from Inheritance Tax but this is due to change from April 2027, when amounts remaining in pensions on death will form part of your estate. 

Using life insurance to pay Inheritance Tax 

Another way to pay Inheritance Tax is through a whole-of-life insurance policy which pays out on death as long as the premiums have been kept up, or a term insurance policy which could provide a lump sum payout on death to cover an Inheritance Tax liability.

It is wise to make sure your life insurance policy is written ‘in trust’ which is something you can do at no extra charge. It means that your life insurance policy won’t be included in the value of your estate and the money will be paid directly to your beneficiaries rather than your legal estate.

This process also means that your beneficiaries would get the policy payout a lot more quickly than waiting for probate to go through.

Note: With a whole-of-life policy you could be paying premiums well into old age, and premiums can increase as you get older. There are also policies that offer fixed premiums for a fixed amount of cover.

Estate planning can be complex and we would advise that you take professional advice from an independent financial adviser like the team at PIL Southampton.

What other taxes do heirs have to pay on their inheritance? 

Beneficiaries, or heirs, of an estate generally don’t pay tax on money and items they inherit. However, they may need to pay related taxes, for example tax on rental income they receive if they have had a house left to them in a will.

Also, people you have gifted money to may be liable to pay Inheritance Tax, if you have given away more than £325,000 and then die within seven years.

Investments that can help reduce IHT 

Certain types of investments can help to reduce your Inheritance Tax liability, which you can read about in our articles ‘Reducing Inheritance Tax with an AIM ISA’ and ‘Reducing Inheritance Tax with Business Relief’. 

How PIL Southampton can help you 

Our qualified and experienced team of independent financial advisers is perfectly placed to talk through all your estate planning needs, and to help to manage your Inheritance Tax liability. 

How you can contact PIL Southampton

You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.