Inheritance Tax guide
Your solicitor or Institute of Professional Will Writers member will be able to advise you in more detail about inheritance tax (IHT), and more importantly, they can tailor this advice to your particular circumstances.
We hope that our general explanation about how IHT works in relation to estates (including charitable gifts) helps.
What is inheritance tax?
Inheritance tax (IHT) can be paid following your death on the value of your estate (and can also include the value of substantial lifetime gifts you have made and some types of trust funds).
Download our Inheritance tax guide
The IHT Threshold – the nil rate band
If the total value of your estate is under £325,000 (the current IHT threshold), there should be no IHT to pay, unless you have made qualifying lifetime gifts or have benefited from qualifying trust funds.
If the total value of your estate is over £325,000, IHT will have to be paid from your estate, generally at 40% on the amount over £325,000 unless there are any exemptions available.
If at the date of death, your estate is worth £400,000 and no further exemptions are available then the IHT payable would be calculated as follows:
- £400,000 - £325,000 = £75,000
- 40% of £75,000 = £30,000 IHT liability
This means that if your estate is worth over £325,000 your beneficiaries will only keep £6,000 out of every extra £10,000 you leave.
Gifts to charities, your spouse or civil partner in your Will are generally exempt from IHT. If you leave a gift to any of these, their value will be deducted from your estate before IHT liability is calculated.
If at the date of death your estate is worth £400,000 and the whole estate is left to your spouse, civil partner or charity, then your whole estate will pass free of tax under spouse, civil partner or charitable exemption.
If at the date of your death your estate is worth £400,000 and 50% passes to charity and the remaining 50% passes to a non-exempt beneficiary (a friend for example), then the £200,000 passing to charity will be free from IHT and the £200,000 passing to your friend will also be free from IHT as this amount is within your £325,000 nil rate band (unless you have made qualifying lifetime gifts or have benefited from qualifying trust funds).
If at the date of death your estate is worth £800,000 and you leave 40% to charity (£320,000) and 60% (£480,000) to non-exempt beneficiaries, then your estate will potentially be taxable. If you do not have the benefit of any other exemptions, have made no qualifying lifetime donations, nor received benefit from a qualifying trust fund then the IHT liability would be calculated as follows:
£800,000 - £320,000 = £480,000
- £480,000 - £325,000 = £155,000
- 40% of £155,000 = £62,000 IHT liability
Because of the way the tax rules work, this IHT liability would usually be paid solely from the non-exempt beneficiaries share of the estate, so that the charities would receive £320,000 and the non-exempt beneficiaries £418,000 (£480,000 - £62,000).
If your intent is to effectively share the benefit of the charitable exemption with all your beneficiaries, you should take legal advice as there is very specific wording which is required in your Will.
Transferable nil rate band
If the first spouse or civil partner in a couple has died without using all of their IHT allowance (for instance if they gave their whole estate to their surviving spouse/civil partner) their unused allowance can now be carried forward and used on the death of the surviving spouse or civil partner to increase the amount of their estate which can pass free of IHT to family or friends.
The maximum increase is 100% of the current nil rate band if none of their allowance had been used, so currently up to £325,000 in addition to your own, making a maximum double nil rate band of £650,000 available.
The application of this can be technical, so please take appropriate legal advice if this is relevant to you.
Residence nil rate band
Recent changes introduced an IHT residence nil rate band which may be claimed in addition to the existing IHT nil rate band currently at £325,000 if the person owns a home or a share in one which forms part of their estate or has sold or 'downsized' their home since 7 July 2015.
The amount of the new residence nil rate band in the tax year 2017/18 is £100,000 and it is due to increase each tax year until it reaches £175,000 in the tax year 2020/21. Any unused residence nil rate band may also be transferred to the estate of a surviving spouse or civil partner in a similar way to the transferable nil rate band.
An inheritance tax threshold of £1 million is due to be achieved by the tax year 2020/21 for married couples and civil partners by a combination of the nil rate band, transferable nil rate band and the residence nil rate band.
As the residence nil rate band can be quite complex in its application, we would recommend that you seek legal advice in relation to this.
The new 10% IHT charity relief
You may also have heard that if you leave over 10% of your estate to charity, that the rate of any IHT due (on any part of your estate where IHT is due) would be reduced from 40% to 36%.
If your estate is over £325,000, use of this would enable you to leave a legacy to charity, whilst reducing the rate of IHT payable which could possibly have a positive impact on non-charity beneficiaries. In some circumstances, you can use this to leave a gift to charity at no cost to the beneficiaries in the Will.
Again, this is quite a technical provision and if it is of interest to you, we would suggest that you speak to a solicitor.
Changes to the IHT allowance or the value of your estate could make a big difference to the amount of tax on your assets, and tax rules do change, so be sure to review your Will frequently.