There are lots of different taxes that someone living in the UK can be liable for, but one of the less well-known ones is inheritance tax.
Compared to more standard forms of income tax, this tends to pass under the radar of many, but it can be very costly to those who are eligible to pay it.
One of the reasons why people frequently neglect to inform themselves properly about inheritance tax is that it is not actually paid during their lifetimes. That can unfortunately lead to a degree of complacency, but that is something you cannot afford.
This article will look at precisely what inheritance tax is and how it works, as well as what can be done to reduce your liability if it applies to you.
What is inheritance tax?
Inheritance tax is a form of taxation that is taken from a person’s estate following their death.
The word ‘estate’ just means everything that you own at the time of your death, which can include property, savings you have in the bank or elsewhere, and possessions. That marks inheritance tax out as different from other forms of taxation in that it is only due after you die, rather than while you are alive.
What that means in reality is that this is a form of taxation that your surviving family members will be liable for, rather than you, yourself. It is a tax that mainly impacts upon those who have earned healthy sums during their lifetimes, and therefore built-up estates of considerable value to leave to their families.
A great many people will never be eligible for it, and those who might be often do not consider it a major issue, because they think there will still be plenty of money and other value left within their estates even after it has been paid.
As with other all kinds of taxation, there is a standard rate at which it is charged. In the case of inheritance tax, that rate is set at 40%. Given how high the rate is, it should be starting to become clear why this is not a financial issue that you can afford to neglect.
Not planning in advance for an inheritance tax bill can seriously impinge upon your hopes of leaving a legacy for your surviving family members. Or, in the worst case scenario, it can leave them facing a bill they will struggle to pay, during a period where they are already grieving your loss.
Who is liable for inheritance tax?
As with every other form of taxation in the UK, the issue of inheritance tax will not be applicable in all cases. There is a threshold below which people do not have to pay inheritance tax on an estate.
What is the threshold for inheritance tax?
In this case, the tax threshold is currently set at £325,000. This is far higher than the threshold for almost all other forms of tax in this country.
What it means is that if the total value of your property, savings and possessions adds up to less than that amount, no inheritance tax will need to be paid on them. However, the valuation of an estate may still have to be reported to HMRC, even if it comes in under the tax threshold.
The first thing that will need to be done is to calculate the value of the estate, and there is an online checker available on the gov.uk website to help people with that. Even if it amounts to less than £325,000, there are some instances where your dependents will have to submit details of its valuation. These include:
• If the deceased gave away more than £250,000 during the final seven years of his or her life
• Died with foreign assets valued at over £100,000
• Had moved abroad for permanent residence at the time of death, having previously been a resident of the UK
• Had life insurance that was awarded to someone who was not either their civil partner or spouse
Those are some of the specific circumstances that can require submission of an estate valuation, even when the total value of the estate comes in below the inheritance tax threshold.
A valuation will also need to be provided if the person who has died gave money away as a gift that was paid into a trust, or had more than one trust for saving money during his or her lifetime.
There are also instances where the surviving family does not have to submit estate value details to HMRC. These are known as ‘excepted estates’. Examples include where the deceased had moved to live away from the UK at the time of death and left UK assets worth less than £150,000, or where the estate is valued at under £3 million, and everything has been left to either a qualifying charity or spouse.
This is a type of tax that mainly applies to those who earn good money during their working lives, and have managed to build up substantial estates. That is why reducing inheritance tax liabilities is a common part of the work done by companies that offer wealth management in Shropshire and other prosperous parts of the country.
If you think your estate will be valued above the threshold, putting together a plan with a professional would be an excellent move. The rules regarding it can be extremely complicated, even if your estate is smaller, so getting expert help is always advisable to ensure that you do not break any of the tax laws.
How does inheritance tax work?
The two key things to understand about how inheritance tax works for those who are eligible to pay it are the 40% rate it is calculated at, and the £325,000 tax threshold. The threshold is still relevant even if your estate is valued above it, because you only have to pay inheritance tax on the part over £325,000.
For example, say your estate at the time of your death is valued at £600,000. You will not be charged inheritance tax on that full amount, but on £275,000, which is the amount left once the threshold is applied. Therefore, your family would have to pay tax at 40% of £275,000.
It is absolutely essential to get an accurate valuation of the estate. The best way to do that is for all of the assets to be listed and valued by a qualified professional, before any outstanding debts are subtracted from the total. The things that can come under the heading of ‘assets’, and that must be included in any valuation, include the likes of cash savings, land, property, vehicles, jewellery, shares and insurance policy payouts. The process should also include record-keeping that outlines how the value of the estate was established. Examples of that can include property valuations conducted by estate agents.
HMRC can potentially request estate records for two decades following payment, so the valuations included must be complete and accurate. Given how complex and time consuming getting a comprehensive valuation of the estate left by a person after they die can be, many people opt to turn to a financial advisor in Shropshire or their local county. These people have the skills and experience to know what exactly is needed to ensure that you stay within the inheritance tax rules when valuing the estate. Not doing so can leave those who are mourning a loss vulnerable to fines or other penalties if they are deemed to have submitted information that is inaccurate or incomplete.
How is inheritance tax paid?
Arranging for inheritance tax liabilities to be paid will be the job either of the person executing the will, or whoever is administrating the estate.
If the person who has died made up a will beforehand, ensuring that any tax due is paid on time will be the responsibility of the will executor. On the other hand, if there is no will, the estate administrator carries the responsibility for making sure the correct amount is paid by the due date.
An inheritance tax bill can be paid off using existing money from the estate of the deceased or by selling estate assets, such as properties or possessions, to raise the cash. HMRC allows six months for the family to pay any tax owed, because it may be necessary to raise the money through sales. After that six-month period, interest starts to be charged on the sum due.
In most cases, these tax liabilities are paid using something called a Direct Payment Scheme (DPS). This enables either the executor of the will or estate administrator to arrange payment of all or part of the bill from cash that the deceased had in a building society or bank account. It has the advantage of completing payment smoothly and quickly, which will reduce the strain on the surviving family at a difficult time.
How can you reduce any inheritance tax liabilities?
Despite the high threshold, an inheritance tax bill can still eat pretty significantly into your estate. The vast majority of people want to be able to leave as much as possible for their families rather than the taxman. For that reason, finding ways of minimising the burden of this tax is one of the key roles of financial advisors or wealth managers.
Fortunately, the rules around it mean that there are perfectly legal methods of reducing what has to be paid. These are the main ones.
• Make up a will in which you leave the part of your estate above the threshold to your spouse or a charity
• Create a will in which you leave your house to your children – this can raise the threshold to £500,000
• Gift at least 10% of your estate’s net worth to charity – this can leave your family liable to pay at a lower rate of 36%.
It should be becoming clear by now that making up a will before you die is important if you think your estate will be liable for inheritance tax, and you want to minimise the burden. Any good financial advice by a professional will encourage you to create a will outlining how your assets are to be disposed of after your death as soon as possible, for precisely that reason.
Outside of reduction strategies, another option is to use the payment from a life insurance policy to cover part of the bill. This will not actually cut the amount of inheritance tax that has to be paid after your death, but it will ensure that it does not eat into as much of the estate.
There are other options available for reducing inheritance tax. Talk to a professional advisor today if you want to learn more about them.
