A Guide to Inheritance Tax

Planning for the future can help to ensure that your loved ones are financially secure when you pass away and allow you to decide who receives what assets. A solicitor experienced in probate law can help you with this task and give you peace of mind for the future.

One of the most important questions when someone dies is who will inherit that person’s property. Under a will, you can specify who will benefit, i.e. who receives what assets. The assets can include property, cash and personal possessions.

However, those who inherit your estate can be faced with unexpected costs, such as Inheritance Tax. Planning how you distribute your estate can help lessen the burden on those who will inherit.

You should speak to a solicitor experienced in probate law who can help you identify the options that may be best for you and your loved ones.

What is Inheritance Tax?

Inheritance Tax is the tax on an estate of someone who has died. Your estate will owe inheritance tax at 40% on qualifying assets above the tax threshold, or 36% if you leave at least 10% of your estate to a charity.

Normally, there’s no Inheritance Tax to pay if the value of your estate is below the £325,000 threshold or if you leave everything to your spouse or civil partner.

Couples can leave a home worth £650,000 without it attracting Inheritance Tax. Giving away your home to your children or grandchildren upon your death will increase the tax threshold to £425,000.

However, George Osborne, former Chancellor of the Exchequer, announced in the Summer Budget of July 2015 that he would scrap the duty when parents or grandparents pass on a home worth up to £1 million (£500,000 for singles).

This is being phased in gradually until April 2020, meaning that passing on your family home to your children or grandchildren will not attract Inheritance Tax for your loved ones.

What is covered by Inheritance Tax?

Property (such as buildings or land), money, investments (such as stocks or shares), and personal possessions.

Any property which passes under your will (or under the intestacy rules if you don’t make a will) falls under the Inheritance Tax remit.

Inheritance Tax also covers the situation where you were beneficially entitled to property, such as you owned a house as a joint tenant, but it does not pass under your will and instead passes by survivorship to the surviving joint tenant.

You may also own certain property because of special statutory provisions, for example property on trust. This also falls under the Inheritance Tax rules.

It’s possible that you may have incurred Inheritance Tax during your lifetime, if you made a gift to a company or into a trust. This is immediately chargeable at the time when it’s made, unless you’ve gifted into a trust for a disabled person.

Your liabilities, which include debts from loans and utility bills, are deductible from your Inheritance Tax bill.

What is exempt from Inheritance Tax?

Life assurance policies are excluded from Inheritance Tax if you have nominated someone to receive the benefits upon your death. A discretionary lump sum payment from a pension fund also escapes Inheritance Tax because the pension trustees are not obligated to pay the amount.

Some property is also excluded from the estate for Inheritance Tax purposes. For example, if you have a ‘reversionary interest’, you will have a future interest under settlement.
As mentioned above, any property passing to a charity is exempt from Inheritance Tax, and if you leave 10% of your estate to a charity, the rate of Inheritance Tax you pay is lowered to 36%.

Some gifts will fall into the ‘potentially exempt transfers’ category—this means that at the time when the transfer is made, Inheritance Tax is not chargeable. If you live for seven years after making the gift, the transfer becomes exempt. But, if you pass away during this time, the transfer becomes chargeable.

Are there any reliefs?

Some reliefs may be available which allow some assets to be passed on free of Inheritance Tax or with a reduced amount.

The main exemption occurs where any property is passed to your spouse or civil partner under your will (or the intestacy rules) or passes by survivorship where the property was held jointly. If this happens, no Inheritance Tax will be payable.

Some gifts, such as those between spouses and civil partners, are always tax-free. In other cases, gifts can be potentially tax-free if they were made more than seven years before your death to an individual, and not to a business or a trust. If you die within these seven years, the gift will be taxed.

If you have business property, such as a share in a partnership or machinery, your estate may be able to claim business property relief. This applies to reduce the value of transfer, but you must have owned the property for the two years immediately before the transfer.

If you owned a business or an interest in a business, the relief reduces Inheritance Tax by 100%. The reduction is 50% for quoted shares which gave you control the company and certain land, buildings and machinery.

Where a gift is a ‘potentially exempt transfer’, other reliefs can apply.

For example, if you made a gift of £250 to your friend in one tax year, this would be exempt. The exemption can’t be set against a gift which exceeds £250.

You also have an annual exemption, which applies to the first £3,000 transferred in each tax year. You’re able to carry the annual exemption forward for one year, meaning that you could have a maximum exemption of £6,000.

Another way that a transfer could be exempt is if it can be shown that the gift was made as part of your normal expenditure and out of your income, and that you were left with a sufficient income.

In some cases, you may want to give a loved one a monetary gift in consideration of marriage. These gifts can be exempt from Inheritance Tax. As a parent, you can give your child up to £5,000 without incurring tax. A grandparent or another ancestor can give £2,500 and any other person can give £1,000.

Tapering relief is available if the person who made a ‘potentially exempt transfer’ gift survives for more than three years after the transfer.

Who will need to pay the Inheritance Tax?

If Inheritance Tax is due, the people dealing with your estate will need to pay the tax to HM Revenue and Customs. The funds will come from your estate.

People you gave gifts to may need to pay Inheritance Tax if you die within seven years of giving the gift. However, if the person you made the gift to doesn’t pay the tax within 12 months after the end of the month of death, the personal representatives (who deal with the estate) will become liable.

It’s vital to seek out the help of a solicitor who can advise you on what estate planning is best for you and any future consequences of your plans.

Should I make a will?

Making a will will allow you to divide up your assets in a way you see fit.

To create a valid will, you must have the necessary mental capacity and intention to do so.

You must be over 18 years old to make the will and you must have the requisite mental capacity. This means understanding the nature of making a will and its broad effects, the extent of your property and the moral claims you should consider.

When you sign a will, you must have intent to make the will (instead of any other document) and intend to make the particular will that is then being executed.

You must also follow the formalities for execution of the will. This means you, as the executor, must sign the will and two other people must witness the signing. The other people must also sign the will. A law firm can provide two people who can witness the will signing.

A solicitor experienced in probate law can also advise you on a plan to dispose of your estate.

Can I revoke my will?

You can always revoke a will during your lifetime provided you have the capacity to do so. There are three main ways of revoking your will, outlined below.

First, you can revoke a will in whole or in part with a subsequent will. The later will will normally contain a clause revoking all earlier wills.

Second, if you marry or form a civil partnership after executing a will, the will is automatically revoked.

If you made a valid will but later divorced your spouse or dissolved your civil partnership, the will will remain valid but any property which is bequeathed to the former spouse/civil partner will pass as if the former spouse/civil partner had died on that date.

Third, a will may be revoked by “burning, tearing or otherwise destroying the same by the testator or by some person in his presence and by his direction with the intention of revoking the same” under section 20 of the Wills Act 1837.

If you want to alter your will, you’ll need to make sure the alterations are executed like a will, otherwise they will not be valid.

What property can and can’t pass under the will?

Under a will, you can provide for the disposition of cash, money in bank and building society accounts, stocks and shares, land and buildings.

But there are some kinds of property that will pass independently of your will or the intestacy rules.

If you own property with someone as a joint tenant, upon your death, your interest will pass by survivorship to the surviving joint tenant.

You can also ‘nominate’ what happens to certain types of funds after your death. Statutory provisions apply to deposits not exceeding £5,000 in certain trustee savings banks and friendly societies. The nomination will direct the institution to pay the money in the account to a chosen third party.

If you take out a policy of life assurance, on your death, the policy will mature and the insurance company will pay the proceeds to your representatives. Your representatives will then distribute the money according to your will or the intestacy rules.

But, it is possible to take out a life assurance policy which is expressed to be for the benefit of specified individuals. Upon your death, the insurance company will pay the proceeds to the those named, regardless of your will.

Most pension schemes will provide for the payment of benefits if an employee dies while still employed. You are normally able to specify who will receive the lump sum of benefits upon your death. Although your choice is not binding on the pension fund trustees, they will normally abide by your wishes.

You should speak to a solicitor who can advise you on what can and can’t be passed under a will.

What if I don’t want to make a will?

If you don’t make a will, the estate will be shared out according to certain rules, called the intestacy rules.

Under the intestacy rules only spouses or civil partners and some other close relatives can inherit your estate. There’s a strict order as to who can benefit—a spouse or civil partner takes priority, followed by children.

A spouse or civil partner will take priority and the whole estate will pass to them. But if the estate’s value exceeds £250,000 and the deceased has children, then the first £250,000 will pass to the spouse/civil partner. The remainder will be split in half, with half going to the spouse/civil partner and half to the children.

If you die intestate, many people will be unable to benefit from your estate. This includes cohabitants, step-children and of these people will be able to benefit from your estate.

If you do want them to benefit or your want to make personal gifts, you must make a will to set out who will inherit your personal possessions and property.