Inheritance tax is charged at a whopping 40% on all assets above a certain threshold that you leave behind when you die.
The good news is that there are steps you can take to minimise the tax bill or even avoid it altogether.
Here’s everything you need to know about inheritance tax.
What is inheritance tax?
Inheritance tax is paid on the assets someone leaves behind when they die.
Assets include cash and investments, property and even antiques and jewellery.
Basically, anything that has value is an asset.
You don’t pay the tax if the value of your assets, known as your estate, is below a certain threshold. More on this below.
Anything above this threshold is taxed at a rate of 40%.
The value of an estate is calculated minus any debts.
For example, if you own a home worth £300,000 on which you have a mortgage of £100,000, the value of your estate would be £200,000 for inheritance tax purposes.
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How much money can you inherit without paying tax on it in the UK?
You won’t pay inheritance tax if you inherit assets worth less than £325,000.
For example, if you inherit a home worth £250,000 and savings and investments worth £70,000, you will not have to pay the tax.
Technically, inheritance tax is paid by the person who has died. As a result, it is based on the total value of assets they leave behind, not the amount that an individual inherits.
If everything you own is worth more than £325,000 but you leave assets above this threshold to your spouse or civil partner, you also won’t need to pay the tax.
You can also avoid paying it if you leave anything above £325,000 to a charity or amateur sports club.
Does inheritance tax apply to the family home?
Yes it does, but the threshold at which the tax kicks in is more generous.
The inheritance tax threshold (or nil-rate allowance) rises to £500,000 if parents leave their home to their children or grandchildren.
So, if your home was worth £300,000 and you had £175,000 worth of savings and investments, you would not have to pay inheritance tax, as long as you left your home to your children and grandchildren.
If everything you own is worth £600,000 and you leave your home to your children, you would only pay inheritance tax on £100,000.
This would give you a bill of £40,000.
Your total estate must also be worth less than £2 million to take advantage of this threshold.
On estates worth £2 million or more, the main residence allowance will decrease by £1 for every £2 above £2 million that the deceased's estate is worth.
So on an estate worth £2,000,002, the main residence allowance would decrease to £499,999 and you would pay inheritance tax on the remaining £1,500,003. And so on.
Estates worth more than £2.7 million will not be entitled to any nil-rate allowance.
What happens if you don’t use all of your inheritance tax allowance?
If you are married or in a civil partnership, you can transfer any unused allowance to your partner when you die.
As a result, their threshold could be as high as £1 million.
For example, if you leave everything to your partner when you die, you will not use any of your allowance.
This means their tax-free allowance will become £650,000 if they do not plan to leave the family home to your children (2 x £325,000), or £1 million if they do (2 x £500,000).
How much money can you gift to a family member tax-free in the UK?
You don’t have to wait until you die to give money to your family.
You can give away £3,000 of money or possessions each tax year without paying inheritance tax.
This is known as the annual exemption.
You can give up to £3,000 to one person or split it between several people.
If you don’t use the full allowance in one year, you can carry it forward to the next tax year.
You can also give £250 per person to as many people as you want each tax year. This is known as the small gift allowance.
You can’t use this allowance if you have used another allowance for the same person.
In addition, you can give money to someone tax free if they are getting married.
You are allowed to give £5,000 to a child, £2,500 to a grandchild or great-grandchild and £1,000 to anyone else.
Money you give for birthday or Christmas gifts is also exempt from inheritance tax. As are payments from your regular income to help with another person’s living costs.
How do I avoid inheritance tax on a parent’s property?
The best way to avoid paying inheritance tax on a parent’s property is to make full use of the combined tax-free threshold for both parents.
This can be as high as £1 million.
Alternatively, your parents could give you the property before they die.
But it will only be free of inheritance tax if two conditions are met.
First, they must live for at least seven years after giving it to you. This is known as the seven-year rule. See below for more details.
Secondly, they cannot continue to live there or even stay there for holidays for free.
If they still continue to benefit from the property in any way, it is known as a gift with reservation. As a result, you will still have to pay inheritance tax on it when they die.
The only exception is if they pay rent on the property at a market rate, as well as pay the bills, and they live there for at least seven years.
They do not have to pay rent if the new owner also lives at the property.
What is the seven-year rule on inheritance tax?
No inheritance tax is paid on any assets you give away if you live for at least seven years after giving them. This is known as the seven-year rule.
If you die before seven years is over, inheritance tax is charged on a sliding scale.
If you die within three years of giving the gift, inheritance tax is charged at 40%.
If you die three to four years later it is charged at 32%, falling to 24% after four to five years, 16% after five to six years and 8% after six to seven years.
How do you beat inheritance tax?
There are a number of steps you can take to reduce the amount of inheritance tax you pay.
Most importantly, make a will. This will ensure your assets go to who you want, and not be distributed according to government guidelines.
Secondly, make maximum use of your allowances.
Pool your inheritance tax allowance with your partner and leave the family home to your children, while making use of your annual gift allowances.
You can further reduce your inheritance tax bill by having life insurance policies written into trust.
This is very simple to do and will mean that any payouts are excluded from inheritance tax calculations.
You could also think about giving some of your assets away in order to benefit from the seven-year rule.
There is a lot you can do, and it is worth starting to plan as early as possible.
What happens if you can’t afford to pay inheritance tax?
Inheritance tax has to be paid before money from the estate is released.
The person dealing with the estate, known as the executor, pays it to HM Revenue and Customs (HMRC).
It needs to be paid within six months of the person’s death. After this date HMRC will start charging interest on the amount due.
Unfortunately, you cannot sell a property you have inherited until inheritance tax has been paid.
This situation creates a problem for many people. But there are special loan products available to tide you over while you pay inheritance tax and then sell the property you were left.
Are there any exceptions under which a different rate of inheritance tax applies?
There are a few exceptions to the rules set out above.
If someone leaves 10% or more of their assets to charity, inheritance tax is paid at a reduced rate of 36% on some assets.
Find out more about reduced rate inheritance tax
If you leave a business, or a share in a business, you may qualify for business relief on inheritance tax.
This means some or all of the business may be free from inheritance tax.
Find out more about business relief inheritance tax
Farms or woodland may also be covered by agricultural relief. If you think this may apply to you, you should contact HMRC for more details.
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