It is important to understand at least the basic rules relating to inheritance tax, including that the latest inheritance tax rates are and when the tax becomes payable. In this way, you can forward plan to help minimise any potential tax bill after you pass away, and maximise the value of your estate for your loved ones.
Calculating inheritance tax liability
Inheritance tax liability will be assessed on the basis of the net value of an individual’s estate in accordance with the applicable inheritance tax rates at the time of death, after taking into account any available exemptions or property relief.
Your estate comprises any money, property and possessions once funeral expenses, administration costs, debts and liabilities have been paid.
If you are married or in a civil partnership you are allowed to pass your money, possessions and property entirely tax-free to your spouse or civil partner.
Further, if the net value of your estate falls below the current nil-rate band (see below), it can be left to any of your loved ones entirely tax-free. In other words, you apply a 0% Inheritance Tax rate on anything below this threshold.
Where your estate exceeds the nil-rate band you will generally be liable to pay tax at 40% on anything over and above that threshold.
A reduced rate of 36% can apply where you gift at least 10% or more of the net value of your estate to charity, although the rules can be complicated here.
Inheritance tax rates for 2022/2023
For the tax year 2022/2023 individuals are entitled to an inheritance tax allowance of £325,000. This is known as the inheritance tax ‘nil-rate band’. The net effect is that you are able to leave up to £325,000 tax-free to your loved ones.
If the value of the estate exceeds the £325,000 threshold, the standard inheritance tax rate will apply at 40%.
The nil-rate band is also transferable as between spouses.
In other words, where any part of the nil-rate band remains unused where one spouse or civil partner passes away, this can be added to the nil-rate band of the other when they die.
This can effectively double the amount the surviving partner can leave behind tax-free. Consequently, married couples and civil partners will be able to pass on up to £650,000 tax-free to their children or other relatives.
If residential property forms part of their estate, this tax-free allowance can be significantly higher under the residence nil-rate band.
Inheritance tax rates & the residence nil-rate band
Under the residence nil-rate band, the first £175,000 of the value of your home will be exempt from inheritance tax.
Where residential property forms part of your estate, you can bequeath as much as £500,000 without your estate incurring any inheritance tax liability – a figure that is potentially doubled for couples.
This means married couples or civil partners can typically pass on up to £1million if their estate includes the home.
For estates with a net value of more than £2million, there is a tapered withdrawal of the residence nil-rate band. Here the amount of available relief is reduced by £1 for every £2 of value by which the estate exceeds the tapered threshold.
To qualify for the new property allowance you must satisfy the following criteria:
- immediately prior to your death your estate includes a qualifying residential interest.
- this residential interest is closely inherited, ie; the property passes to a direct descendant. This includes children, grandchildren, great grandchildren, and any spouse or civil partner of these descendants.
You do not need to be living in the property at the time of your death. However, it must be a property that at some point during your life you have used as a residence. This, therefore, excludes buy-to-let or investment properties, unless you have previously resided in any such property.
In the event that you downsize, you may still benefit from some, or all, of the residence nil-rate band. The downsizing provisions provide that if both the downsized residence and other assets in the estate are inherited by direct descendants, the estate will still qualify for an additional amount of property relief.
This will be broadly equal to the lower of the amount of the residence nil-rate band and the value of the other assets inherited by the children, grandchildren or great grandchildren.
Inheritance Tax rates & taper relief on lifetime gifts
During your lifetime you are able to gift a certain amount of money tax-free. Currently there is an annual gift exemption of £3,000 worth of gifts each tax year without them being added to the value of your estate.
Some gifts do not count towards this annual exemption, ie; they are automatically tax-free. This includes gifts between spouses, small gifts made out of your normal income or gifts to charity.
Gifts falling outside these exemptions are known as ‘potentially exempt transfers’ (PETs). Broadly speaking, if a gift is made within seven years of death it may be subject to inheritance tax at a rate of 40%, albeit on a sliding scale depending on the timeframe. The amount of taper relief increases with the number of calendar years between the date of the gift and the date of death.
Applying this taper relief, the inheritance tax rates payable on a gift are 32% for gifts made between 3-4 years, 24% for gifts made between 4-5 years, 16% for gifts made between 5-6 years and 8% for gifts made between 6-7 years of the date of death.
After seven years, gifts will not be counted towards the value of your estate. Further, if the total value of the gifts does not exceed the nil-rate band, no tax is payable on the gift.
Inheritance tax rates & chargeable lifetime transfers
Most lifetime gifts are not immediately chargeable to inheritance tax, not unless the donor dies within seven years of making the gift.
However, there are certain classes of transfer that attract inheritance tax if they, together with any similar transfers made within the preceding seven years, exceed the nil rate band at the time the transfer is made. These are known as ‘chargeable lifetime transfers’.
In particular, where a trust is set up inter vivos, ie; during the settlor’s lifetime, rather than by Will, any transfer into the trust will be treated as a chargeable lifetime transfer attracting an immediate entry charge.
Any entry charges are calculated on the basis of the excess of the value of the transfer over and above the available nil-rate band. This is payable at the lifetime rate of 20%.
Unless specifically exempt, many trusts are also subject to what is known as the ‘relevant property tax regime’. This imposes a number of additional inheritance tax charges on all relevant property during the lifetime of the trust. As such, a liability to Inheritance Tax may also arise when a trust reaches a 10-year anniversary or where part or all of the trust fund is distributed to a beneficiary.
Broadly speaking, both 10-yearly periodic and exit charges are payable at a rate of 30% of the effective lifetime rate, ie; currently 6%, on the excess of the value of the trust fund over and above the nil-rate band.
Who pays the inheritance tax bill?
The amount of inheritance tax due when a person dies will be paid for out of their estate.
The estate will be made up of all of the individual’s money, possessions and assets, less any debts such as a mortgage or funeral costs.
The tax liability must be paid by the end of the sixth month after the person’s death.
If tax is due on lifetime gifts, the recipients of the gifts will usually be liable for the tax bill, to the estate will be charged if the recipient cannot or will not pay.
Inheritance tax rates – key takeaway
Inheritance tax rates can have significant financial implications for your loved ones after you die.
If you wish to minimise the amount of tax payable on your estate following your death you should consider how the inheritance tax rules can work in your favour.
As the rules can quickly become complex, seeking professional advice is highly recommended.
Inheritance tax rates FAQs
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Legal disclaimer
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.
