How Inheritance Tax Works: Rules and Allowances

One area of tax which always attracts a lot of attention is Inheritance Tax (IHT). IHT is generally charged at a rather eye-watering flat rate of 40% and can have a significant impact on the value of the Estate you leave to your loved ones. Thankfully there are ways in which you can reduce and even eliminate this punishing tax; awareness of the rules and allowances can really help. Careful planning can be beneficial too – it’s quite useful to think of this tax as a voluntary one!

What is IHT?

IHT is generally charged on your Estate when you die and your wealth moves to your heirs. It also applies to any gifts made in the seven years before your death, and to some types of Trusts. It’s pretty notorious, especially given, unlike other taxes, it’s not usually tapered in any way with a flat rate of 40% applying.

How does the IHT Nil-Rate Band work?

IHT does have a tax-free allowance, known as the Nil-Rate Band. This applies to any Estate, and means that no tax has to be paid at all on the first £325,000 of your wealth. It’s worth noting that the Band hasn’t changed since 2009, and the UK government have confirmed that the allowance will be frozen until at least 2028. Given the increase in property prices alone during this period, more Estates now fall into the IHT net than ever before. However, generally there is no IHT bill if you leave your entire Estate to your spouse or civil partner.

What is an additional IHT allowance?

The additional IHT allowance was introduced in 2017. It applies to residences and can ‘top-up’ the Nil-Rate Band allowance if you leave a property you’ve lived in (or the value of such a property) to your direct descendants. This can include step and foster children as well as your children and grandchildren. There are a few caveats which apply if your property is worth more than £2 million. As with the Nil-Rate Band the allowance can be transferred between spouses or civil partners. 

What are some of the IHT allowances?

There are a number of additional allowances which it can be useful to bear in mind, and use if you are concerned about a future IHT bill on your Estate. It’s also worth noting that gifts to charity are usually exempt so it’s worth considering this option if you’re keen to leave a legacy.

Annual Exemption

Every person has an annual exemption, free from IHT, of £3,000. There’s also another helpful tax-free tool known as ‘normal expenditure out of income’. This allows you to help others out of your normal income, perhaps to pay your child’s rent or add to a grandchild’s savings account on a monthly basis provided various conditions are met.

Weddings and partnerships

If you choose to make a financial gesture as part of a wedding gift or civil partnership then certain specific allowances are on hand:

  • £5,000 to a child
  • £2,500 to a grandchild or great-grandchild
  • £1,000 to any other person

Small gifts

Every tax year you’re able to gift up to £250 to as many people as you’d like, without any fears about IHT.

Reducing IHT

When it comes to reducing IHT, planning ahead is key. It can be particularly useful to spend some time working out what you need to maintain your preferred lifestyle, and consider whether you can begin to share your Estate with your chosen beneficiaries during your later years, ahead of your death. Even if you’d prefer to keep your Estate intact it’s always helpful to use your allowances wisely and make sure your Will stays up to date so that your instructions are clear. There are various strategies you can use to reduce your IHT bill based on your circumstances.

Help with your IHT planning

We’ve been helping families manage intergenerational wealth for over 120 years. Our supportive team of experts can help with all aspects of Estate planning, including IHT planning. Contact your nearest office today.

Would you like to find out more?

We are here to help with your financial planning requirements. For more information, whatever your circumstances, please contact us today.