What is inheritance tax and when do you pay it?

In the UK, inheritance tax is a tax levied on the value of a deceased person’s estate, which includes their property, money, possessions and other assets. It is also sometimes referred to as the ‘death tax’. When a person passes away, their estate is subject to inheritance tax if its value exceeds a certain threshold, known as the ‘inheritance tax threshold’ or the ‘nil-rate band’.

If the value of the deceased person’s estate is below this threshold, there would be no inheritance tax to pay. However, if the estate value exceeds this amount, inheritance tax is applicable unless there are exemptions and reliefs available to the estate.

When do you pay inheritance tax?

Payment of inheritance tax must be made within six months of a person’s death and needs to be paid before a Grant of Probate (or Letters of Administration if there is no Will) can be obtained. Interest for late payment of inheritance tax will start after six months of the end of the month in which the death occurred.

The inheritance tax attributable to certain assets, such as property, can be paid annually in equal instalments over a ten-year period, but interest will apply to the sums outstanding. Inheritance tax cannot be deferred in the same way on assets such as savings and personal possessions.

If there are insufficient cash funds in an estate to pay the initial inheritance tax bill, the personal representatives will need to obtain the funds from elsewhere if they are to obtain the Grant. This could be through third-party lenders or through a life insurance or pension policy left by the deceased or payable as a result of their death.

How is it calculated?

The standard inheritance tax rate is 40% on the value of the estate above the nil-rate threshold, which for a single unmarried person is currently £325,000. The nil-rate threshold may be reduced by the capital gifts made by the deceased exceeding their annual allowance (£3,000) within the seven years immediately preceding their death. Any gifts exceeding the annual allowance of £3,000 will be treated as though they are still within the estate.

For example, if the deceased person’s estate is worth £500,000 and in the seven years immediately preceding their death they made gifts above their annual allowances of £100,000, their taxable liability would be calculated as follows:

£500,000 less their available nil-rate band (£325,000 – £100,000) @ 40%, which is £110,000.

This is on the basis the deceased died never having married and without children or more remote descendants (e.g. grandchildren).

What is the benefit of being married for inheritance tax?

Gifts to spouses are exempt from inheritance tax and can be made to an unlimited value so long as it is not a gift from a UK domiciled individual to a non-UK domiciled individual. Additionally, the nil-rate allowances can transfer across to a surviving spouse if they have not been used on first death.

This means the personal representatives of the surviving spouse can claim a combined nil-rate band of £650,000 on second death, or up to £1m if the deceased’s estate qualifies for the main residence nil-rate band (and the transfer of the unused allowance from the first estate).

Does the nil-rate allowance increase if I have children?

An additional allowance called the main residence nil-rate band can apply to an estate which holds a main residence and leaves assets outright to a child or lineal descendant. The estate must be valued under £2m to be eligible for the full allowance of £175,000 after which the allowance tapers down.

For married couples, it is possible for the estate of the last individual to die to claim both allowances on second death if not already used, making a total allowance of £350,000 claimable under this allowance.

What is the seven-year rule?

The seven-year rule is a significant aspect of inheritance tax planning. This rule relates to gifts made by the deceased person during their lifetime.

If someone gifts money, property or other assets to an individual or a trust, without there being an applicable exemption or relief, and they survive for at least seven years after making the gift, it becomes exempt from inheritance tax so long as the gift is properly executed, and the individual doesn’t retain any ongoing benefit from the gifted assets. This gift is known as a ‘potentially exempt transfer’ (PET).

However, if the person who made the gift dies within seven years of making the PET, the gift will become a failed PET and instead becomes  a ‘chargeable  transfer’ for IHT purposes. This means that it will be taken into account for the individuals IHT calculation.

The tax rate on these gifts usually reduces if the donor survives between three and seven years from the date of making the gift but only to the extent the gift exceeds the available nil-rate allowance. This is known as’ ‘taper relief’.

There is the scope for a tax consequence on chargeable transfers going back up to 14 years, often called the ‘backward shadow’ but this is beyond the scope of this article.

What does the effect of gifting to charity have on inheritance tax?

Gifts to charity are deducted from your taxable estate. Additionally, if you were to gift 10% or more of your estate, or parts of your estate, a discounted rate of 36% (instead of 40%) can apply to some or all of your estate.

What reliefs are available?

There are a number of reliefs available to reduce your estate for inheritance tax. The eligibility of an estate to the reliefs is usually dependent on the nature of the assets held at the time of death. For example, reliefs are available for certain business interests and agricultural property. Reductions can also be claimed for co-owned assets where the asset could not be sold at full market value as a consequence of the multiple-ownership.

It’s essential to keep meticulous records of any gifts made during your lifetime to ensure accurate calculations and minimise potential tax liabilities for your beneficiaries.

Please note that tax laws and regulations can change over time, and they can be particularly complex, so it is crucial to consult with an experienced and qualified professional for the most up-to-date and accurate information.

Autumn Budget and inheritance tax

In the Autumn Budget 2024, the Government announced reforms to agricultural property relief (APR) and business property relief (BPR) from inheritance tax.

From April 2026, IHT relief for business and for agricultural assets will be capped at £1m, with a new reduced rate of 20% being charged above that (rather than the standard inheritance tax rate of 40%). The range of pensions death benefits subject to IHT has also been extended, with pension pots passing to future generations forming part of an estate for IHT purposes.

Nina Sperring, Wealth Protection Partner at Price Slater Gawne, said “The Autumn Budget will have a huge impact on future generations and retirement.

“Careful and clever estate planning can help navigate these changes. This is an area that we specialise in; we can advise clients to help cater for future generations.”

We can help advise you with your inheritance tax planning and completing your inheritance tax returns when someone you know dies. If you would like to speak to a member of our team, please contact 03333 058375 or email WealthProtection@psg-law.co.uk.