Inheritance Tax: what is it and how does it work?

Inheritance Tax 10 June 2022

While most of us won’t have large enough estates to worry about Inheritance Tax (IHT), it’s wise to understand how it may affect your assets when you pass away. If you'd like to leave your wealth to the people and causes you care about most, it definitely pays to understand the basics.

In our guide, we’ll explain everything you need to know including what Inheritance Tax is, how it works, how to start planning ahead and ultimately how to get Inheritance tax advice.

What is Inheritance Tax?

Inheritance Tax is a tax which the government applies to the estate passed on to your family when you die. An estate includes the total of everything owned by one person, or anything owned jointly. This can include assets such as property, investments, insurance and assets such as cars, jewellery or furniture. But if there’s nothing to pay, your loved ones will still need to report it to Her Majesty’s Revenue and Customs (HMRC).

Usually, Inheritance Tax is payable on any estate totalling more than £325,000. If your estate is above the £325,000 threshold, then you’ll be liable to pay tax on the amount at a rate of 40%.

How is Inheritance Tax calculated?

Inheritance Tax can be tricky to calculate. Usually, the executor(s) of a will need to calculate any tax owed on an estate after you die. The calculation should include everything in your estate, including all your assets. Even gifts you've made in the past seven years before your death may be taxed.

We’ll explain more about the 7-year in inheritance tax rule later. But first, let’s explore what could count towards your estate.

What could count as part of your estate

  • Any gifts you make in the seven years before you die
  • Property, including your home and rental property
  • Investments such as individual savings accounts (ISAs), bonds or pensions
  • Cash held in bank accounts or with building societies
  • Physical assets such as furniture, jewellery or vehicles
  • Insurance policies that aren’t in a trust

There are also some great tools out there to help with your sums, such as this handy inheritance tax calculator from Which? Valuing an estate can be a complex and confusing task. So, if you need support, speak to a financial adviser.

Do spouses or partners pay Inheritance Tax?

There are special exceptions couples when it comes to Inheritance Tax. For example, if you died and left everything over the £325,000 threshold to your civil partner or spouse, they usually wouldn’t have to pay.

And if your estate is worth less than the threshold, you can pass unused threshold to your spouse or civil partner’s threshold after your death. This would increase their threshold, so it’s a good idea to start planning ahead if you want to ensure your loved ones aren’t liable to pay Inheritance Tax.

If you’re in a couple that isn’t married or in a civil partnership, things get more complicated. Your partner may have to pay Inheritance Tax if you have joint ownership of a property. You also can’t pass assets between yourself and your partner, tax-free. Marriage or a civil partnership will give you access to this exemption and other tax benefits. Speak to a financial adviser if you would like to explore other options to reduce IHT such as putting your assets in their name.

Inheritance tax planning

How to start planning ahead for Inheritance Tax

There’s a lot to bear in mind when you're planning ahead for what happens to your estate after you die. But by taking the time to review your assets and situation, you can plan ahead to ensure your loved ones aren’t left with a huge bill.

Here are a few steps to help you get started with Inheritance Tax planning.

Make your will

By having a will in place, you’ll have peace of mind that you can pass your estate on to the people and causes you care about most when you die. If you haven’t written a will, it’s a good idea to start one and keep it up to date.

There are many things to consider, such as who you would like to appoint as your executor and how you want to distribute your estate. Age UK’s making a will guide can help you get started. 

Set up a trust

Using a trust could reduce the Inheritance Tax your loved ones may have to pay. How it works is that the trust lets you set aside money for one or more beneficiaries or a company.

When you set up a trust, you can pass on money, investments or property. Putting assets into a trust also transfers the ownership to the trustee. This is why they’re not counted as part of your estate and not liable for Inheritance Tax.

For example, you could set up a trust for your grandchildren or a trust to help your child pay university fees, which they can access at a certain age. If you’re considering setting up a trust, speak to a professional financial adviser. They’ll explain the many different types of trusts and options available, and whether it would be the most appropriate option for you

Close up of gift for senior woman stock photo

Give gifts to friends, family or charities

Gifting to family and friends could help you take advantage of exemptions or reduce Inheritance Tax liability. While your gift may be a loving gesture to celebrate a birthday, or a ‘thank you’, these gifts may count towards your £325,000 threshold. But, there are many situations where gifts are exempt:

  • Gifts under £3,000 made in any tax year
  • Assets you pass to your spouse or civil partner (as long as they’re a permanent UK resident)
  • Gifts of £250 or less
  • Wedding or civil partnership gifts are tax-free if your gift is:

    - Up to £5,000 for your son or daughter
    - Up to £2,500 for your grandchild or great grandchild
    - Up to £1,000 for anyone else

Outside of these exemptions, you may give away a total of £3,000 each tax year under your ‘annual exemption’. Anything after this will count towards the value of your estate. And if you give a monetary gift to a charity or political party, they’ll be exempt from paying Inheritance Tax, no matter how large that amount is.

What is the 7-year rule in Inheritance Tax?

According to the 7-year rule, Inheritance Tax won't apply to gifts a person gives if they live for seven or more years after the date the gift was given. Your annual exemption also means you can give up to £3,000 worth of gifts per tax year. But if your gifts exceed this amount, they’ll count towards your estate.

If the gift is part of a trust, it will be subject to Inheritance Tax. If the person does die within seven years, the gift will also be subject to IHT - but the amount of tax will all depend on when the gift was issued.

Of course, there’s no way to know when you’ll die. That's why it's crucial that you record all the gifts you make if you’re in poor health or want to prepare for the unexpected.

A financial adviser can help you plan ahead and keep track of the gifts you make, so you can reduce the Inheritance Tax your loved ones may have to pay.

Consider getting life assurance

Unlike life insurance which only lasts for a certain period of time, a life assurance policy ensures you’re covered for life. While this type of policy won’t reduce your Inheritance Tax liability, it’s guaranteed to pay out. This payout can help soften the blow for your named beneficiary if they’re faced with Inheritance Tax.
Another option is to put the life assurance policy into trust. Doing so could reduce your liability and may mean a faster payout - but there are exceptions. Working with a financial adviser could help you determine whether this is the most suitable option.

Get advice from a financial adviser 

Inheritance Tax rules are complex and failure to understand them could mean your loved ones may not get as much as you’d like. Working with a financial adviser can help you pass on more of your estate. As experts in tax rules and legislation, they’ll have the experience to help you:

  • Understand how IHT may impact your loved ones and estate
  • Discover tax-efficient strategies to reduce your tax liability
  • Take advantage of exemptions
  • Track and keep accurate records of your gifts and entire estate


How we can help you connect to an Inheritance Tax expert

Getting your finances in order and thinking about Inheritance Tax planning is a big task. The good news is that you don’t have to struggle on your own. From Belfast to Bristol, our FCA-regulated financial adviser partners have the expertise to help you find your way.

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