Inheritance Tax, Explained

It is often colloquially said that there are two certainties in life: death, and taxes. Unfortunately, one often begets the other – or so is the case concerning Inheritance Tax in the UK. Inheritance Tax is often misunderstood and can lead to some surprises for members of a family in the event of a loved one’s death. What is it, how does it work and how can you mitigate its impact?
 

What is Inheritance Tax?
 

Inheritance Tax, or IHT, is a tax liability that applies to monies and assets left to loved ones in the event of one’s death. The tax is a simple and flat one, amounting to 40% of monies above a specific threshold (more on which later) – though there are circumstances and procedures by which tax relief or tapering can be arranged.
 

The tax applies to the totality of an individual’s estate, and payment of such becomes necessary in the event of execution of the will.
 

Who Pays IHT?
 

Inheritance Tax is paid by the executor of the will, as the will is honoured and named recipients receive their allocated portion. By and large, the beneficiaries in a given will do not have their own tax burden regarding inheritance; this may change with regard to specific circumstances, such as the reception of a property that generates its own income.
 

There is also a specific instance in which a given recipient of money or assets is required to make their own inheritance tax payment. In the event that someone gifts in excess of £325,000 in value to a given beneficiary, and dies before seven years have passed, the beneficiary will be required to pay IHT on the ‘excess’ – though potentially at a ‘tapered’ percentage depending on the dates of the gift-giving.
 

IHT Rate and Threshold
 

As things stand, there is a nil-rate tax band that protects the first £325,000 in value of a given estate. Any value above this threshold is taxed at a flat 40% rate. The nil rate has been in place since 2009 and has not been adjusted for inflation in the intervening years.
 

Indeed, the recent cost of living crisis has seen remarkable inflation, with significant impacts on spending power and serious consequences for households. Between this and the rampant rise in property values (with property often being the largest constituent part of the average estate, the Treasury has seen its largest tax haul ever.
 

Managing IHT in Your Estate Planning
 

With IHT being a major diminishing factor in the awarding of estates to beneficiaries, many people take advantage of specific processes to minimise its impact. Estate planning is the act of structuring finances and assets in favour of tax efficiency and with the best interests of loved ones in mind.
 

One of the leading ways to reduce the IHT burden on given beneficiaries is to divert funding and assets to trusts before your death. In doing this, you technically relinquish ownership of said funds and assets, reducing the size of your estate and thus the taxable portion of your estate.