What taxes will my estate incur and how will they be paid?

Inheritance Tax (IHT) is a tax levied on a deceased’s estate. The estate is, with a few exceptions, everything the deceased owns immediately before death. Normally the tax is charged at 40% of the value of the estate. However there are lots of exemptions that mean currently only about 1 in 20 estates pay any IHT. We explain these exemptions below.

Leaving all or part of your estate to your husband, wife or civil partner

The good news is that any gifts made in your will to your spouse or civil partner are free of IHT. In other words if you leave all your assets to your spouse or civil partner there will be no IHT to pay. Also any inheritance left to your spouse (husband/wife/civil partner) does not use up your ‘Nil Rate Band’. We explain what that is below.

The nil rate band

Each person has a “nil rate band” – an amount they can leave to anyone free of IHT. Currently the nil rate band is £325,000 per person. In other words, if your estate is worth less than £325,000 there will be no IHT to pay.If you leave part of your estate to someone other than your spouse or civil partner then this uses up your nil rate band.
The nil rate band is “transferable” between spouses/civil partners. This means that when one spouse dies, any unused part of their nil rate band is passed on to their spouse/civil partner.
Here is an example:

  • Bob leaves an estate worth £500,000 on his death.
  • He leaves £400,000 of his estate to his wife Mary – this is free of IHT and does not use up his nil rate band.
  • Bob leaves the remaining £100,000 to his daughter Alice – this is free of IHT but uses up £100,000 of Bob’s £325,000 nil rate band allowance.
  • The remaining £225,000 of Bob’s nil rate band allowance is automatically passed on to his wife Mary. This means that Mary now has a nil rate band of £550,000 for use on her death. £325,000 of her own nil rate band plus the additional £225,000 that Bob didn’t use on his death.

Exempt gifts made in your will

Some gifts made in your will are exempt from IHT, meaning that they do not attract IHT at all (and do not use up the nil-rate band). The most important exemptions are gifts between spouses or civil partners and gifts to charities.

Gifts made during your lifetime

The value of gifts made in the seven years before death form part of your estate. For IHT purposes they are taxed on a sliding scale: 40% IHT is payable if the gift was made within three years of death, reducing over time to 0% for gifts made more than seven years before death. This is to prevent people avoiding inheritance tax by giving away their estate just before their death. These gifts are part of the estate and therefore do use up the nil-rate band.
Some gifts made during your lifetime are also completely exempt from IHT. These include:

  • Gifts worth up to £3,000 in each tax year. This is called the ‘annual exemption’.
  • Wedding/civil partnership gifts (up to £5,000 to a child, up to £2,500 to a grandchild or great-grandchild and £1,000 to anyone else).
  • Individual gifts worth up to £250.
  • Regular gifts from income.
  • Gifts to help with another person’s living costs.

Gifts to charity

Gifts to charity do not attract IHT or use up your nil rate band. In addition if a will leaves more than 10% of the estate to charity, the remainder of the estate is taxed at 36% rate of IHT on that part of it which exceed the nil rate band.

Tax reliefs

Some other gifts made in a will attract relief on IHT. These are:

  • Businesses passed on as a going concern
  • Agricultural property
  • Woodlands
  • Cultural heritage

How is inheritance tax paid?

Inheritance tax is paid by the executors of the will out of the estate. Where a gift in a will is expressed to be “free of tax”, then any IHT related to that gift is usually paid out of the residue of the estate.