Inheritance Tax, often abbreviated as IHT, is a government levy on the estate of a person who has passes away. It encompasses all of their money, property and personal possessions. Even in circumstances where no IHT is due to be paid, Her Majesty’s Revenues and Customs (HMRC) must still receive proper notification. If you’ve been plagued by concerns regarding IHT and have been trying to answer the question “how does inheritance tax work?”, read on for all you need to know.
What are the circumstances where paying inheritance tax might not be necessary?
There is typically no IHT due to be paid in several different situations. For example, IHT payments are not charged when the value of a person’s estate is less than the nil rate band. The nil rate band is a set threshold that currently stands at £325,000. As long as an estate is valued to be below this figure, no levy will be requested.
If a person dies and leaves the entirety of their estate beyond the allowable £325,000 to a spouse or a civil partner, no IHT payment is required. The same rule also applies if they choose to leave funds above the threshold to an amateur sports club or registered charity.
Additionally, there are options that can increase the nil band rate from £325,000 to £500,000. This is the case if, when a person dies, they bequeath their home to either their grandchildren or children.
However, if these options are not taken, and the worth of a person’s final estate has a value above the threshold, all value beyond the £325,000 threshold can be taxed by the government at a tax rate of 40 per cent.
Passing on the property where you live
As mentioned, a person can pass on their home to either a civil partner or spouse when they die, leaving no IHT to pay.
However, if a person leaves their home to someone else in their will, it will count as part of an estate’s value for taxation purposes.
The residence nil rate band (RNRB) can extend the tax-free threshold when a home is left to certain family members. Along with children and grandchildren, the list of potential beneficiaries can also include foster children, adopted children and stepchildren. However, siblings, as well as nephews and nieces, are excluded from this option.
Are there any expected changes to IHT nil rate bands?
The Finance Bill for this year revealed that nil band rates for IHT will stay at their existing levels until at least the new tax year in 2026.
Is it possible to pass on any of your threshold that remains unused?
It is possible for both civil partners and married couples to pass on their unused threshold to one another. Until 2026, the nil rate band is currently fixed at £325,000, but a person’s nil rate band may be increased if they have outlived their civil partner or have been widowed. The law states that couples are allowed to transfer any unused nil rate band remaining when one of them dies, passing it on to their surviving spouse or civil partner.
This rule can effectively double the available amount of nil rate band, increasing it to £650.000. The term for this additional transferable element is transferable nil rate band, or TNRB for short.
It may also be possible to make use of any unused RNRB from a civil partner or spouse’s estate if a person is a surviving civil partner or widowed. This can then double the amount of available RNRB.
How do you value a person’s estate?
The basic steps to valuing a person’s estate when they die involves listing every asset they possess and working out their value at the time of death. Once this figure has been calculated, any liabilities and debts must be deducted.
It is essential to keep detailed records of how these calculations were completed. For example, how much a person’s home is worth when they die may be informed by a property agent’s professional valuation. These records are essential and should be kept safely for a period of at least 20 years. HMRC is entitled to request to see these documents for up to two decades after an IHT bill has been paid.
A person’s assets include a wide range of different items, such as money in a personal bank account, land and properties, stocks and shares, jewellery and vehicles. Payments from insurance providers can also qualify as assets.
Gifts, such as cash and other assets, must also be detailed if they were given away before a person dies, unless they were gifted seven or more years before death. Gifts will also need to be included if they were given prior to this period, but the person who passed away kept benefiting from the gift. The term used to describe these gifts is ‘with reservations of benefit’. An example of such a gift is when a person gives their home away, but continues to be a resident at the address.
Liabilities and debts will reduce the value of a person’s chargeable estate when they die. These include outstanding credit card payments, utility bills, mortgages and the cost of funeral arrangements.
However, any costs required after death, like fees for probate or those paid to solicitors, can’t be subtracted from the value of an estate for the purpose of IHT.
Expertise in IHT mitigation strategies
At Hartey Wealth Management, our expertise lies in developing tax-efficient strategies that can effectively reduce how much inheritance tax must be paid on your estate.
If you’re worried about how your family will be provided for after you have gone, our methods can make certain more of your wealth is passed on to your beneficiaries, rather than HMRC.
If you’re still wondering “how does Inheritance Tax work?”, or you have concerns about how it could impact your personal circumstances, we can help. For assistance from expert retirement planning specialists in Chester and Shropshire, contact our dedicated team today.