A Guide to Inheritance Tax in the UK

A Guide to Inheritance Tax in the UK

Two things in life that are inevitable are death and taxes. These are two realities of life that we cannot escape no matter how hard we try. When we talk about taxes, the tax that most people in the UK resent more than the others is inheritance tax or IHT. A major reason for people’s resentment towards IHT is that it is related to a loved one’s death. It would be a mistake, however, to disregard inheritance tax only because you despite it. Here, we include an understanding of how inheritance tax works, the exemptions available, and what can be done to minimize IHT in the United Kingdom.

What Is IHT and How Does It Work?

The tax charged on assets—including money, real estate, and possessions—owned by a deceased person is referred to as inheritance tax (IHT). Your heirs could be charged up to 40% of your estate as tax if you plan to pass on your money or assets to them after you die.

The amount of tax that your heirs will have to pay will depend on the total value of the assets that are passed onto them after your death. Assets that can be passed on to others after your death and are taxable include property, cash in the bank, payouts from life insurance policies, and vehicles. By subtracting any debt you have from the total value of the assets you wish to pass on, you will arrive at the total value of your assets.

The parts of your IHT-subject estate are established based on your domicile rather than your residence. Domicile may be a complex concept, but in general terms, it is the place that is (or is considered to be) your permanent home or birthplace. HMRC will decide where you have been resident for the last twenty tax years and your links to the UK to determine your domicile.

If you are domiciled in the United Kingdom (or assumed to be domiciled in the United Kingdom because you have spent at least fifteen of the last twenty tax years residing in the United Kingdom), all UK and foreign assets are considered your assets for IHT purposes.

On the other hand, only UK assets are subjected to IHT if you are domiciled abroad (often alluded to as ‘non-domiciled’ or ‘non-dom’), although special rules mean that certain common UK investments are excluded.

IHT Rate in the UK

As per the 2020/21 tax rates in the UK, the first £ 325,000 of the estate you leave behind for others is not taxable. This is something that is often referred to as the ‘nil-rate band’. However, anything above this amount you leave behind will be taxed at 40%.

However, the above applies only when you’re passing on an estate to someone other than your children or grandchildren. While the basic allowance remains at £ 325,000, an additional allowance—referred to as ‘main residence’ band—is available to you in case you want to pass on your estate to your children or grandchildren.

This main residence allowance increased to £ 175,000 in 2020/21, which ensures that no inheritance tax will be paid on the first £ 500,000 of their estate.

However, this allowance is only available for an estate value of less than £2 million. For an estate worth more than this, you will lose a pound for every £2 of the value of your estate above £2 million.

IHT Exemptions

IHT is not charged on an estate inherited by a UK domiciled spouse or civil partner of the deceased. If you are UK domiciled but your partner is non-domiciled, you may opt to be considered as being the UK domiciled (upon your death), or else the spousal exemption is confined to £ 325,000.

In addition to the above, the estate passed to qualifying political parties, registered charities, housing associations, and other organizations working in the interest of a community or country are exempt from IHT.

How to Minimize IHT

The following are some ways you can minimize the IHT payable for those inheriting your estate:

  • Pass on your estate to your spouse or civil partner
  • Make a will
  • Give away gifts worth £3,000 during a year
  • Leave part of the estate to charity
  • Make payments into a pension rather than a savings account
  • Keep your estate in a trust for your heirs

Final Word

If you’ve made a fortune after years of struggle and hard work, you have every right to enjoy what you have earned. However, at some point in your life, you will need to plan what will happen to your wealth after you die. This is especially important if you have a spouse or civil partner, children, and/or grandchildren in your family.

If you plan for your inheritance now including the tax payable on it, your heirs will appreciate it for many years to come after your death.

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