Inheritance tax: a basic guide

14 December 2020
If you plan to pass on assets or money in your will to loved ones, it is important to ensure you pay inheritance tax or your heirs could face a tax bill on 40% of your estate. The rules around inheritance tax can be tricky to understand, so this basic guide will walk you through everything you need to know.
Image john fowlers inheritance tax guide
Inheritance tax is money you pay on possessions, property and money you leave behind when you pass away, otherwise known as your ‘estate’. If it’s not paid, inheritance tax can cost your loved ones thousands when you pass away, at a time when they are already going through trauma, yet it is possible to avoid paying none at all when handled the right way.

Why do you have to pay inheritance tax?

Many people question why they are effectively being taxed twice on their assets - once while earning them throughout their life and then the second time when they pass away. The reason this was introduced is based on redistributing wealth for the benefit of the general public. 

Inheritance tax thresholds and rates 2020/21

There is no inheritance tax due on the first £325,000 of an estate. However, above that amount, anything you leave behind could be subjected to 40% tax. How much you pay depends on the value of your estate, from cash in the bank, investments, property owned, business, vehicles and life insurance policies. 

There is usually no tax to pay if either: 

  • The estate is below £325,000 
  • You leave everything over £325,000 to your spouse, civil partner, a charity or community.

To break it down with an example, if your estate is worth £400,000, you will only pay tax on the £75,000 (£400,000 minus the threshold of £325,000, making £30,000 payable).

What are the rules if you’re married?

When you pass away, assets and possessions left to your spouse are exempt from inheritance tax (providing they live in the UK). This means that a spouse can leave all that they own to their spouse entirely free of inheritance tax in most cases. 

Your partner is allowed to use both tax-free allowances, providing you do not use up all the inheritance tax allowance by giving away a large sum of money. 

For the tax year 2020-21 most married couples or civil partners can pass on up to £650,000 or £1million if the estate includes your home, effectively doubling the amount the surviving spouse can leave behind tax-free without the need for special taxing plans.

How to reduce inheritance tax when not married

If you’re married or you are in a civil partnership, it is the easiest way of avoiding greater inheritance tax impact. However, there are other way you can reduce the tax amount: 

  • Transferring assets - this is a good way to protect your joint assets.
  • Gifting your assets to others. 
  • Place your assets in a trust - this way they no longer become part of your estate.
  • Take out life insurance - this will not directly impact a potential inheritance tax bill, but it will cover the tax cost for your loved ones. 
  • Leave a portion of your estate to charity - if you leave a minimum of 10% of your estate, the tax rate will be reduced from 40% to 36%.

Who pays the inheritance tax bill?

Everyone is subject to inheritance tax, but paying for it depends on the value of your estate. Inheritance tax due on money or possessions is usually paid from your estate when you pass away. Your estate is made up of everything you own, apart from debts such as your mortgage.

Your heirs must pay inheritance tax by the end of the sixth month after the person died. To do this an inheritance tax reference number is provided by HMRC which should be applied for at least three weeks before a payment is made.

However, if you have any tax due on gifts you made in your will during the 7 years before your death, the people who received the gifts must pay inheritance tax in most circumstances. If they can’t or will not pay, the amount then comes out of your estate.

Our solicitors at John Fowlers specialise in inheritance tax and will writing, and are happy to offer expert legal advice - contact our team today to learn more.