Inheritance Tax: Part One: The basics

“…but in this world nothing can be said to be certain, except death and taxes.”

The above quote is largely attributed to Benjamin Franklin.

The tax that might have to be paid when you die is called Inheritance Tax and whilst paying it is not a certainty, the amount of inheritance tax collected has doubled over the last five years, and the number of estates paying inheritance tax has nearly tripled over the same period.

If the legacy that you leave does have an inheritance tax liability, it is the very people you want to benefit as much, that will have to pay it.

The good news is that there are plenty of things you can look at doing during your lifetime to help take care of this potential problem.

Before, we look at what you can to do to reduce or mitigate a potential liability, it’s worthwhile getting familiar with the basics and then looking at what makes up your estate and how inheritance tax is calculated:

When you die, your ‘estate’ is made up of the assets you leave behind minus any liabilities you may have

What counts as an asset

An asset is anything you own with a value (this means it’s worth money or could be sold), including:

  • money in a bank or building society account
  • property and land
  • personal belongings, eg jewellery
  • cars
  • stocks and shares
  • trusts
  • pensions that include a ‘lump sum’ payment on death*
  • a payout from a life insurance policy
  • jointly owned property, bank accounts or other assets

Where something is jointly owned, then value your share e.g. 50%

*You don’t usually pay Inheritance Tax on a pension lump sum because payment is usually ‘discretionary’ – this means the pension provider can choose whom to pay the money to.

What counts as a liability

This includes anything that you owe when you die, things you are responsible for paying, like:

  • mortgages
  • loans
  • credit card balances

If you have a liability, like a mortgage, with someone else, only deduct your share of the mortgage.

The Nil Rate Band

The Nil Rate Band ( NRB ) is the amount you can pass on in the event of death without incurring an inheritance liability. It currently stands at £325,000.

From April 2017, an additional NRB is being introduced, called the main residence nil rate band. This will benefit most homeowners who pass their homes onto direct descendants. This will start at £100,000 and increases to £175,000 by April 2020.

If you have made some gifts during the past 7 years you may be able to take these into account. In addition, charitable donations left in your will can reduce your liability. We’ll cover this in a future article.

Your marital status:

Whether or not you pay inheritance tax will be influenced to some degree by your marital status.

Single:

If you’re single and your estate is worth more than £325,000, anything over that amount will be liable for up to 40% inheritance tax. You may also benefit from the new main residence nil rate band from April next year.

Married/civil partnership

If you’re married or in a civil partnership, the assets you leave to your spouse will be transferred without any inheritance tax to pay, because leaving assets to a spouse does not use up your nil-rate band.

If you pass on any of your estate to someone other than your spouse or civil partner, and your estate is valued at more than £325,000, then the excess will be subject to up to 40% inheritance tax.

The estate of your surviving spouse, now widowed, will be subject to inheritance tax as outlined below.

Both you and your spouse could also benefit from the main residence nil rate band.

Widowed

When someone dies, their unused nil-rate band can be transferred to their spouse or civil partner.

For example, if your spouse left everything to you before they died, you could potentially have a combined nil-rate band of £650,000 applied to the

value of your estate.

You could also benefit from the main residence nil rate band.

Unmarried couple

If you are part of an unmarried couple, you are still treated as single for inheritance tax purposes. This means that each of you has a separate nil-rate band of £325,000 which cannot be combined upon death.

You may each benefit from the main residence nil rate band.

Some examples:

 All examples assume, death occurs in tax year 2017/18 when the main residence nil rate band becomes effective.

 

Mandeep is single. He owns his home, valued at £400,000, with a small mortgage of £75,000. He has savings and investments totaling £275,000

 

Add total value of all assets £675,000
Deduct total value of all liabilities

 

£75,000
Less Nil Rate Band (NRB) £325,000
Less Main Residence NRB

 

£100,000
= Taxable Value of Your Estate

 

£175,000
Inheritance Tax at 40% = £70,000

 

 

Mary is married to Simon. They co-own their home, valued at £600,000. Mary has savings and investments are £160,000 and she is joint owner with Simon of investments worth £80,000. Upon her death, Mary leaves everything to Simon.

 

Add total value of Mary’s assets £500,000
Deduct total value of all liabilities

 

£0
Less Nil Rate Band (NRB) Not utilised
Less Main Residence NRB

 

Not utliised
= Taxable Value of Your Estate £0
Inheritance Tax at 40% = £0

 

As all of Mary’s assets are passed directly to Simon, there is no tax to pay even though she is over the NRB threshold. Her NRB has not been used, so upon Simon’s death he will able to make use of Mary’s NRB, as well as his own, currently a total of £650,000.

 

 

George was widowed 10 years ago. When his wife dies he inherited all of her assets. George lives in a house worth £750,000 and has savings and investments totaling £120,000. He has pension fund valued at £375,000.

 

Add total value of all assets £870,000
Deduct total value of all liabilities

 

£0
Less Nil Rate Band (NRB) £650,000
Less Main Residence NRB

 

£100,000
= Taxable Value of Your Estate £120,000
Inheritance Tax at 40% = £48,000

George nominated his daughter to benefit from his pension fund. Inheritance tax is not payable on this sum. As well as George’s NRN that of his widow can also be used, as it was unsed when she died.

 

Julie and Ian have been living together for 15 years, they have not got married.

Julie leaves everything she owns to Ian upon her death. Her share of the home is £250,000 and she has investments worth £220,000. They gave two children.

 

Add total value of all assets £470,000
Deduct total value of all liabilities

 

£0
Less Nil Rate Band (NRB) £325,000
Less Main Residence NRB

 

£0
= Taxable Value of Your Estate £145,000
Inheritance Tax at 40% = £58,000

 Because they are not married, there is a tax liability for Ian upon Julie’s death.

  

In our next article we’ll take a look at the inheritance tax exemptions that exist, the benefit of making gifts during your lifetime and charitable donations.

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