When someone dies, there are rules to determine what happens to their money, possessions and property (their “estate”, in the taxman’s language). This can sometimes mean there’s tax to be paid along the way – called, appropriately enough, Inheritance Tax.
The standard rate for Inheritance Tax is a massive 40%, but you won’t end up paying it from the first penny you inherit. In fact, the tax doesn’t kick in at all unless the total value of the estate is at least £325,000 – and even then, it only applies to the portion of the estate that’s above that £325,000 threshold.
There are a few wrinkles in the system to be aware of, which can mean there’s no Inheritance Tax to pay. For one thing, if you’re leaving everything above the threshold to a spouse or civil partner, there’s no Inheritance Tax. The same thing goes if you’re leaving it to a charity or amateur sports club. In fact, the estate can even qualify for a reduced Inheritance Tax rate of 36% on some of its assets if at least 10% of its total net value is left to charity.
Also, if you’re leaving your home to your kids (including fostered or adopted children) or grandkids, then the threshold goes up to £500,000. That only counts if your estate’s worth under £2 million in total, though. For every £2 it’s worth over that limit, the tax-free allowance goes down by £1. For married people or couples in civil partnerships, the unused portion of that threshold can be combined with your partner’s when they die, potentially bumping it up as high as £1 million.
There’s another Inheritance Tax exemption for certain kinds of gifts that the owner of the estate gives out before they die. Yes, even presents you give while you’re alive can sometimes be counted for Inheritance Tax. For instance, if you give away more than £325,000 of your stuff and then die within 7 years, your beneficiaries will be looking at an Inheritance Tax bill. Depending on the situation, though, the actual rate might be less than the standard 40%. There’s also an annual “gift exemption” that lets you give away up to £3,000 a year tax-free while you’re alive.
Here’s the thing to watch out for, though. Even if the total value of an estate is under whatever threshold applies, you’re not off the hook altogether. Even if there’s no Inheritance Tax to pay, you still need to report the inheritance to HMRC.
Let’s put it in real terms. Let’s say the estate you’re inheriting’s worth exactly half a million pounds, with a standard tax-free threshold of £325,000. The top £175,000 of that brings a tax bill of 40% down on you.
So who’s actually paying all this tax then? Well, the money comes out of the estate itself, but the person actually doing the paperwork for it is called the “executor”. By the time the inheritance makes its way to the actual beneficiaries there won’t normally be anything left to pay on it, since the executor’s usually handled it already. There may still be some other taxes involved, though. For instance, if you inherit a property that’s being rented out, the rental income will still count as taxable income.