With rising property prices, more and more people face the possibility of paying inheritance tax (IHT). We explain when you’d need to pay it and how much the bill could be.

By Alistair McQueen, Head of Savings and Retirement at Aviva

Inheritance tax, or IHT, is a tax on people’s wealth when they die. It dates back hundreds of years and was used in the late 18th century to help Britain fund its war against Napoleon.

IHT was originally aimed at only the wealthiest in society, but over time, and especially as property prices have risen, the number of people paying it has gone up. Over the past decade the amount of IHT paid each year doubled from £2.7 billion in 2010/11 to £5.4 billion in 2020/21, 1 so it’s a good time to look at when IHT would be due and how much money it might involve.

This is a general guide to the topic. If you think you might be affected by IHT, you should get professional advice. The information is based on our interpretation of the rules for tax year 2021/22 and, as always, tax benefits are subject to change and depend on the individual’s circumstances.

When IHT needs to be paid

Inheritance tax is a tax on your estate when you die. Your estate comprises your property, money and possessions. Pensions aren’t usually included for IHT purposes as they’re not legally defined as being part of the estate – one of the leading attractions for many people of investing in a pension.

For the tax year 2021/22, the first £325,000 of an estate is exempt from IHT. This is known as the 'nil‐rate band'.

Most people get a 'residence nil‐rate band' which is a further allowance of £175,000 on top of the nil‐rate band. It can be claimed against a primary residence that was owned by the deceased and is to be passed on to a direct descendant.

Together these bands add up to a potential IHT allowance of £500,000 for many people – one of the reasons that in 2018 to 2019 only around 4% of deaths in the UK currently end up needing IHT to be paid.2

If you’re married or in a civil partnership, there’s no IHT to pay on any part of your estate that transfers to your spouse or civil partner, no matter how large it is. And your IHT allowance also passes to them, giving a potential total allowance of up to £1 million before any IHT would be payable when they then die. That figure is the total of the nil‐rate bands for both people plus each’s entitlement on the primary residence.

How much it will cost

If the value of an estate exceeds the IHT allowances, the IHT that needs to be paid is 40% of the amount above the allowance.

For example, let’s look at single person whose estate is valued at £600,000. Half of this (£300,000) is the value of their house and the other half is their money and possessions.

As they’re entitled to the full residence nil‐rate band if they pass the property on to a direct descendant, their total IHT allowance would be £500,000. The estate would need to pay IHT of 40% on the £100,000 above their allowance – a tax bill of £40,000.

The value of advice

That’s a relatively straightforward example, but IHT can get very complicated very quickly.

For example, it’s possible to reduce the IHT liability if at least 10% of the estate is gifted to charity; certain factors could reduce the residence nil‐rate band; and it’s possible that in some relatively unusual situations, pension wealth may not be exempt. The value or cost of these factors depends very much on your personal situation.

It’s best to carry out your IHT planning when the full range of options is still available, so thinking about your circumstances early makes good sense. If you think you may be one of the 4% whose estate could be liable for inheritance tax, it’s a very good idea to get professional advice sooner rather than later.

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