Inheritance Tax (IHT) can affect what you leave behind for loved ones. It’s essential you understand if it’s something you need to think about, as there could be steps you can take to reduce a potential bill.
Over the last few months, you’ve read about what estate planning is and how to calculate the value of your estate. Mitigating an IHT bill should be an important part of your estate plan if you could be liable for it. Read on to find out when IHT is due.
The standard rate of Inheritance Tax is 40%
With a standard rate of 40%, IHT could substantially reduce the value of what you leave behind for loved ones. According to HMRC, around 3.76% of estates pay IHT.
IHT is a tax on your estate after you pass away if the total value exceeds certain thresholds. There are two allowances that you could use:
- If the value of your estate is below the nil-rate band, your estate will not be liable for IHT. For the 2023/24 tax year, it is £325,000.
- Should you leave your main home to your children or grandchildren, you may also be able to use the residence nil-rate band. For the 2023/24 tax year, it is £175,000.
As a result, you could leave up to £500,000 before IHT is due.
You can also pass on unused allowances to your spouse or civil partner. So, if you plan as a couple, you could leave an estate valued at up to £1 million before it’s liable for IHT.
The portion of your estate that exceeds these allowances is usually taxed at 40%.
Let’s say you leave behind assets worth £600,000 to your child, including your main home to take advantage of the residence nil-rate band. The first £500,000 can be passed on without being liable for tax. However, there would be a tax charge of £40,000 on the £100,000 that exceeds the allowances.
You should note both the nil-rate and the residence nil-rate band are frozen at the current level until April 2028. While the value of your estate is below the threshold now, will this still be the case in five years?
To plan effectively, you should consider how the value of your estate could change.
A plan is essential if you want to mitigate Inheritance Tax
There are often steps you can take to reduce a potential IHT bill. Creating a plan now could mean your loved ones inherit more of your estate.
There are lots of steps you can take to reduce IHT during your lifetime, including:
- Gift assets during your lifetime. You could support your loved ones by gifting assets now or during your lifetime. However, keep in mind that only some gifts will be outside of your estate for IHT purposes immediately. Others may still be included when calculating IHT for up to seven years. Contact us to discuss how to gift to reduce IHT liability now.
- Place assets in a trust. Placing assets in a trust could mean they are outside of your estate and, in some cases, you may still be able to benefit from the assets. You will need to name a trustee that will manage the assets on behalf of your beneficiaries. Trusts can be complex, especially if you need to consider IHT, so professional advice can be useful.
- Leave some of your assets to charity. This could bring the value of your estate below the IHT threshold. If you leave more than 10% of your entire estate to charity the IHT rate will fall from 40% to 36%, which could lower the bill for some families.
- Keep the value of your estate below the IHT threshold by spending. Make the most of your later years by spending more – it could mitigate an IHT bill if it brings the value of your estate below the threshold for paying IHT.
There may be other things you can do too. Contact us to create a tailored estate and IHT plan.
As well as steps to mitigate IHT, you may also want to create a plan for paying a bill. This could include setting money aside so it’s there when your family need it.
Another option is to take out a life insurance policy. You’d need to pay premiums and the policy proceeds could give your family the cash they need to cover an IHT bill.
You must ensure a life insurance policy that’s intended to cover IHT is written in trust, otherwise, the payout will be considered part of your estate when calculating IHT.
Contact us to talk about your estate plan and Inheritance Tax
If you’d like help understanding if your estate could be liable for IHT, or you want to discuss your options to potentially reduce a bill, please get in touch.
While estate planning often focuses on organising your affairs to pass on assets when you die, it can also cover steps to improve your long-term financial security. Next month, read our blog to discover what steps you could take to make your later years more secure.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The Financial Conduct Authority does not regulate estate or tax planning.
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FAQs
Estate planning tasks include making a will, setting up trusts and/or making charitable donations to limit estate taxes, naming an executor and beneficiaries, and setting up funeral arrangements.
Is there a difference between inheritance tax and estate tax? ›
The main difference between inheritance and estate taxes is the person who pays the tax. Unlike an inheritance tax, estate taxes are charged against the estate regardless of who inherits the deceased's assets.
What amount should be included as part of the decedent's gross estate? ›
The gross estate includes all property owned in whole or in part by a citizen or resident at the time of his or her death. Property included in the gross estate can be real or personal, tangible or intangible, and located anywhere.
What is the most you can inherit without paying taxes? ›
In 2024, the first $13,610,000 of an estate is exempt from taxes, up from $12,920,000 in 2023. Estate taxes are based on the size of the estate. It's a progressive tax, just like our federal income tax. That means that the larger the estate, the higher the tax rate it is subject to.
What are the two main components of estate planning involve? ›
A good estate plan consists of many different components, including what happens to your assets and who should act on your behalf if you are unable to. At a bare minimum, there should be two main components: a last will and testament and a durable power of attorney.
What are three elements of an estate plan? ›
A: The three main priorities of an estate plan are to ensure that your assets are distributed in the way you prefer, that someone else has the authority to make decisions on your behalf if you are unable to do so, and that your beneficiaries are clearly defined.
Is an inheritance tax a tax on heirs at death? ›
An inheritance tax is a tax on assets, such as money or a home, that are inherited from someone who died. The person who inherits the assets pays the tax, and rates can vary based on the size of the inheritance as well as the inheritor's relationship to the deceased.
Do I have to claim inheritance as income? ›
Inheritances are not considered income for federal tax purposes, whether you inherit cash, investments or property. However, any subsequent earnings on the inherited assets are taxable, unless it comes from a tax-free source.
Does inheritance count as income? ›
Inheritances are not considered income for federal tax purposes, whether the individual inherits cash, investments or property.
Do I have to report the sale of inherited property to the IRS? ›
Upon selling an inherited asset, if the inherited property produces a gain, you must report it as income on your federal income tax return as a beneficiary.
For example, a state may charge a 5% tax on all inheritances larger than $2 million. Therefore, if your friend leaves you $5 million in their will, you only pay taxes on $3 million, which is $150,000. The state would require you to report this information on an inheritance tax form.
What are three 3 available deductions from a decedent's gross estate? ›
All debts of the decedent, such as property taxes accrued before death, unpaid income taxes on income received by the decedent during life, and unpaid gift taxes on gifts made by the decedent during life are deductible from the gross estate.
Which states impose an inheritance tax? ›
States with inheritance taxes (Iowa, Kentucky, Nebraska, Maryland, New Jersey, and Pennsylvania) also use various exemptions and tax rates. For example, in New Jersey, surviving spouses, parents, children, and grandchildren are all exempt from the tax.
How do I deposit a large cash inheritance? ›
A good place to deposit a large cash inheritance, at least for the short term, would be a federally insured bank or credit union. Your money won't earn much in the way of interest, but as long as you stay under the legal limits, it will be safe until you decide what to do with it.
Do I have to report inheritance to Social Security? ›
You may be tempted to disclaim or refuse your inheritance in the hopes that the SSA won't find out about it. However, federal law requires you to report any changes in income to the SSA. You have up to 10 days following the end of the month in which the change occurred to report income shifts to the agency.
What is the best definition of estate planning? ›
The most common Estate Planning definition is — "the process of making plans for the management and transfer of your estate after your death, using a Will, Trust, insurance policies and/or other devices." Estate Planning has been around for many years, but it's becoming increasingly more and more common.
What is the meaning of estate planning? ›
Estate planning covers the transfer of property at death as well as a variety of other personal matters and may or may not involve tax planning. The core document most often associated with this process is your will.
What is the best definition of estate planning quizlet? ›
The best definition of estate planning is. A definite plan for managing property during one's lifetime and at one's death.
What is the legal definition of estate planning? ›
Estate planning is the process by which an individual or family arranges the transfer of assets in anticipation of death. An estate plan aims to preserve the maximum amount of wealth possible for the intended beneficiaries and flexibility for the individual prior to death.
