Inheritance tax

What's your future worth?

Inheritance tax – or IHT as it’s often referred - is a tax on wealth at death. It dates back hundreds of years. It was used in the late 18t h century to help Britain fund the war against Napoleon.

IHT was originally designed for only the wealthiest in society. As time’s gone on - especially as property prices have risen - the numbers paying inheritance tax have risen too. According to the figures for tax year 2017/18 the estates of more than 20,000 were liable for IHT - and in 2019/20 IHT contributed more than £5bn 1 to government funds. The figure of 20,000 deaths should be kept in context as it only equates to about 4% of deaths each year. 96% of estates don’t incur inheritance tax.

Who pays inheritance tax?

As with all taxes, inheritance tax is subject to possible change. So, this explanation is based on the current rules.

Inheritance tax is a tax on the estate - that is the property, money and possessions - of someone who's passed away. Pension pot wealth is typically excluded from inheritance tax calculations as it’s not legally defined as being part of the estate. For many people, this IHT exclusion continues to be one of the leading attractions of investing in a pension.

The reason why IHT doesn’t apply in 96% of deaths is because of a system of allowances and exemptions. 

The first £325,000 of an estate is exempt from IHT. This figure is often referred to as the 'nil-rate band'.

In 2017 the government introduced an additional allowance on top of this nil-rate band. This is referred to as the 'residence nil-rate band' and provides an additional allowance of £175,000 on top of the nil-rate band. This £175,000 can be claimed against a primary residence that was owned by the deceased and is to be passed on to a descendant.

The nil-rate band of £325,000 plus the residence nil-rate band of £175,000 takes the total inheritance tax exemption up to a possible £500,000 for many individuals.

IHT doesn’t apply to an estate that transfers to a spouse or civil partner on death, no matter how large it is. So, it’s often only on the second death in a family that IHT is assessed as being payable. If a spouse or civil partner dies, their allowance passes to the surviving spouse or civil partner giving that person an allowance of up to £1m before any IHT is due.

As shown by the numbers, most people (around 96%) die with an individual estate valued at less than £500,000, or £1m as a couple.

How much inheritance tax could be paid?

If the value of your estate exceeds these allowances, an inheritance tax charge of up to 40% is levied on the surplus. So, if your estate - including your primary residence - is valued at £600,000, and your allowances total £500,000, the estate will be liable for a tax bill of 40% on the surplus £100,000. That would equate to a tax bill of up to £40,000, paid by the estate.

The value of advice on inheritance tax liabilities

As with many other taxes, inheritance tax can be complicated. For example, it’s possible to reduce the IHT liability if some 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 from inheritance tax.

If you think you may be one of the 4% who could be liable for inheritance tax, it’s a good idea to seek professional financial advice.