Inheritance tax — a summary

Inher­i­tance Tax (IHT) is levied on a per­son­’s estate when they die and cer­tain gifts made dur­ing an indi­vid­u­al’s life­time.

In this fact­sheet the term spouse includes mar­ried cou­ples and reg­is­tered civ­il part­ners. Gen­er­al­ly, gifts between spous­es are exempt. More detail on this aspect and oth­er spe­cif­ic exemp­tions is includ­ed below. Where an exemp­tion does not apply, most gifts made more than sev­en years before death will also escape tax. There­fore, if you plan in advance, gifts can be made tax-free and result in a sub­stan­tial tax sav­ing.

We give guid­ance below on some of the main oppor­tu­ni­ties for min­imis­ing the impact of the tax.

It is how­ev­er impor­tant for you to seek spe­cif­ic pro­fes­sion­al advice appro­pri­ate to your per­son­al cir­cum­stances.

Summary of IHT

Scope of the tax

When a per­son dies IHT becomes due on their estate. IHT can also fall due on some life­time gifts but most are ignored pro­vid­ing the donor sur­vives for sev­en years after the gift.

The rate of tax on death is 40% and 20% on life­time trans­fers where charge­able. Cur­rent­ly, the first £325,000 is charge­able to IHT at 0% and this is known as the nil rate band.

Residence nil rate band

An addi­tion­al nil rate band was intro­duced for deaths on or after 6 April 2017 where an inter­est in a qual­i­fy­ing res­i­dence pass­es to direct descendants.The amount of relief was ini­tial­ly phased in but is cur­rent­ly £175,000. For many mar­ried cou­ples and reg­is­tered civ­il part­ner­ships (here­after referred to as spous­es in this fact­sheet) the relief is effec­tive­ly dou­bled as each indi­vid­ual has a main nil rate band and each will also poten­tial­ly ben­e­fit from the res­i­dence nil rate band.

The res­i­dence nil rate band can only be used in respect of one res­i­den­tial prop­er­ty which does not have to be the main fam­i­ly home but must at some point have been a res­i­dence of the deceased. Restric­tions apply where estates (before reliefs) are in excess of £2 mil­lion.

Where a per­son died before 6 April 2017, their estate will not have qual­i­fied for the relief and if the first spouse has died since then they may not have used the relief. A sur­viv­ing spouse may be enti­tled to an increase in the res­i­dence nil rate band if the spouse who died ear­li­er has not used, or was not enti­tled to use, their full res­i­dence nil rate band. In fact this often results in a dou­bling of the res­i­dence nil rate band for the sur­viv­ing spouse.

Downsizing

The res­i­dence nil rate band may also be avail­able when a per­son down­sizes or ceas­es to own a home on or after 8 July 2015 where assets of an equiv­a­lent val­ue, up to the val­ue of the res­i­dence nil rate band, are passed on death to direct descen­dants.

Charitable giving

A reduced rate of IHT applies where 10% or more of a deceased’s net estate (after deduct­ing IHT exemp­tions, reliefs and the nil rate band) is left to UK char­i­ties. In those cas­es the 40% rate will be reduced to 36%.

IHT on lifetime gifts

Life­time gifts fall into one of three cat­e­gories:

• a trans­fer to a com­pa­ny or a trust (except a dis­abled trust) is imme­di­ate­ly charge­able
• exempt gifts which will be ignored both when they are made and also on the sub­se­quent death of the donor, eg gifts to char­i­ty
• oth­er out­right trans­fers will be poten­tial­ly exempt trans­fers (PETs) and IHT is only due if the donor dies with­in sev­en years of mak­ing the gift. An alter­na­tive way of look­ing at this is that they are poten­tial­ly charge­able until sev­en years has passed. The pri­ma­ry exam­ple of a PET is a gift to anoth­er indi­vid­ual.

IHT on death

The main IHT charge is like­ly to arise on death. IHT is charged on the val­ue of the estate treat­ed as ben­e­fi­cial­ly owned by the deceased. This may include cer­tain types of inter­est in trust prop­er­ty. Fur­ther­more:

• PETs made with­in sev­en years become charge­able
• there may be an addi­tion­al lia­bil­i­ty because of charge­able trans­fers (usu­al­ly life­time gifts to trusts) made with­in the pre­vi­ous sev­en years.

Estate planning

Much estate plan­ning involves mak­ing life­time trans­fers to utilise exemp­tions and reliefs or to ben­e­fit from a low­er rate of tax on life­time trans­fers.

How­ev­er, care­ful con­sid­er­a­tion needs to be giv­en to oth­er fac­tors. For exam­ple a life­time gift may save IHT but may alter­na­tive­ly cre­ate a Cap­i­tal Gains Tax (CGT) lia­bil­i­ty. Fur­ther­more the prospect of sav­ing IHT should not be allowed to jeop­ar­dise the finan­cial secu­ri­ty of those involved.

Gifts between spouses

Gifts between spous­es as stat­ed ear­li­er are gen­er­al­ly ful­ly exempt, if both are either UK ‘long term res­i­dent’ or both non ‘long term res­i­dent’. Long term res­i­dence is res­i­dence of at least 10 years in the UK. Spe­cial rules apply where only one spouse is ‘long term res­i­dent and it means that the spouse exemp­tion may be restrict­ed. It is rec­om­mend­ed that advice is always sought if this applies to ensure reliefs are max­imised. It may be desir­able to use the spouse exemp­tion to trans­fer assets to ensure that both spous­es can make full use of life­time exemp­tions, the nil rate band and PETs.

Gifts to individuals during their lifetime

As these gifts are PETs rather than charge­able trans­fers when made, no tax at all is due if the donor sur­vives for sev­en years. Even where a death occurs with­in sev­en years IHT may be saved as a result of the life­time gifts because the charge is based on the val­ue at the date of the gift and does not include any growth on val­ue to date of death.

These rules only apply to out­right gifts. Where a ben­e­fit is retained, such as the gift of a house in which the donor con­tin­ues to live rent free, spe­cial rules apply and the donor is treat­ed as still own­ing the asset for IHT. Pro­fes­sion­al advice should always be tak­en before con­sid­er­ing such actions.

Nil rate band and seven year cumulation

Charge­able trans­fers (such as life­time gifts to trusts) cov­ered by the nil rate band can be made with­out incur­ring any IHT lia­bil­i­ty. Once sev­en years have elapsed between charge­able trans­fers an ear­li­er trans­fer is no longer tak­en into account in deter­min­ing IHT on sub­se­quent trans­fers. There­fore every sev­en years a full nil rate band will be avail­able to make life­time charge­able trans­fers.

Transferable nil rate band

It is pos­si­ble for spous­es and civ­il part­ners to trans­fer the nil rate band unused on the first death to the sur­viv­ing spouse for use on the death of the sur­viv­ing spouse/partner. On that sec­ond death, their estate will be able to use their own nil rate band and in addi­tion the same pro­por­tion of a sec­ond nil rate band that cor­re­sponds to the pro­por­tion unused on the first death. This allows the pos­si­bil­i­ty of dou­bling the nil rate band avail­able on the sec­ond death. This arrange­ment can apply where the sec­ond death hap­pens after 9 Octo­ber 2007, gen­er­al­ly irre­spec­tive of the date of the first death.

Annual exemption

An amount of £3,000 per annum may be giv­en by an indi­vid­ual with­out an IHT charge. Any unused annu­al exemp­tion may be car­ried for­ward one year only, for use in the tax year that imme­di­ate­ly fol­lows.

Small gifts

Gifts to indi­vid­u­als not exceed­ing £250 in total per tax year per recip­i­ent are exempt. The exemp­tion can­not be used to cov­er part of a larg­er gift.

Normal expenditure out of income

Gifts which are made out of income which are typ­i­cal and habit­u­al and do not result in a fall in the stan­dard of liv­ing of the donor are exempt. Pay­ments under deed of covenant and the pay­ment of annu­al pre­mi­ums on life insur­ance poli­cies would usu­al­ly fall with­in this exemp­tion.

Family maintenance

A gift for fam­i­ly main­te­nance does not give rise to an IHT charge. This would include the trans­fer of prop­er­ty made on divorce under a court order, gifts for the edu­ca­tion of chil­dren or main­te­nance of a depen­dent rel­a­tive.

Wedding presents

Gifts in con­sid­er­a­tion of mar­riage are exempt up to £5,000 if made by a par­ent with low­er lim­its for oth­er donors.

Gifts to charities

Gifts to UK reg­is­tered char­i­ties are exempt pro­vid­ed that the gift becomes the prop­er­ty of the char­i­ty or is held for char­i­ta­ble pur­pos­es.

Business property relief (BPR)

When ‘busi­ness prop­er­ty’ is trans­ferred there is a per­cent­age reduc­tion in the val­ue of the trans­fer. Often this pro­vides full relief. It is avail­able on world­wide assets. In cas­es where full relief is avail­able there is lit­tle incen­tive, from a tax point of view, to trans­fer such assets in life­time. Addi­tion­al­ly no CGT will be payable where the asset is includ­ed in the estate on death. Pro­fes­sion­al advice should be sought to deter­mine whether you have qual­i­fy­ing busi­ness prop­er­ty.

Agricultural property relief (APR)

APR is sim­i­lar to BPR in that it reduces the val­ue of the trans­fer but it may not give full relief on the val­ue. It is avail­able on the trans­fer of agri­cul­tur­al prop­er­ty so long as var­i­ous con­di­tions are met. APR is restrict­ed to UK assets only from April 2024.

Restriction on BPR and APR

From 6 April 2026, qual­i­fy­ing agri­cul­tur­al and busi­ness prop­er­ty will con­tin­ue to ben­e­fit from the 100% IHT relief up to a lim­it of £2.5 mil­lion. The lim­it is a com­bined lim­it for both agri­cul­tur­al and busi­ness prop­er­ty. Such prop­er­ty in excess of the lim­it will ben­e­fit from a 50% relief. This allowance will be trans­fer­able between spous­es and civ­il part­ners.

The changes may have a sig­nif­i­cant impact for some clients. Please con­tact us to dis­cuss if you have busi­ness or agri­cul­tur­al inter­ests in excess of £2.5 mil­lion.

Use of trusts

Trusts can pro­vide an effec­tive means of trans­fer­ring assets out of an estate whilst still allow­ing flex­i­bil­i­ty in the ulti­mate des­ti­na­tion and/or per­mit­ting the donor to retain some con­trol over the assets. Pro­vid­ed that the donor does not obtain any ben­e­fit or enjoy­ment from the trust, the prop­er­ty is removed from the estate.

We can advise you on whether a trust is suit­able for your cir­cum­stances and the types of trust arrange­ments avail­able.

Life assur­ance

Life assur­ance arrange­ments can be used as a means of remov­ing val­ue from an estate and also as a method of fund­ing IHT lia­bil­i­ties.

A pol­i­cy can also be arranged to cov­er IHT due on death. It is par­tic­u­lar­ly use­ful in pro­vid­ing funds to meet an IHT lia­bil­i­ty where the assets are not eas­i­ly realised, e.g. fam­i­ly com­pa­ny shares.

Com­plex­i­ty — is your Will up to date?

Indi­vid­u­als have both a nil rate and a poten­tial res­i­dence nil rate band avail­able to mit­i­gate IHT. Care­ful con­sid­er­a­tion is need­ed by spous­es as to whether these should be used in full or part on the first spouse death or whether they should be trans­ferred to the sec­ond spouse for use. There are a num­ber of fac­tors to be con­sid­ered includ­ing the over­all val­ue of the com­bined estate. Poten­tial­ly a sec­ond spouse has £650,000 of stan­dard nil rate band and £350,000 of res­i­dence nil rate band if noth­ing is used on the first death, in oth­er words £1 mil­lion in total before IHT is charge­able.

This will only be achieved by care­ful plan­ning how­ev­er and, in some cas­es, it may be bet­ter for the first deceased spouse to give some assets to the next gen­er­a­tion and use up their own nil rate band and res­i­dence nil rate band. Piv­otal to this plan­ning is an up to date Will to ensure that any reliefs avail­able are effi­cient­ly utilised.