The Story

Money that is left to you in a will may be taxed at a whopping 40%. Yes you read that right. 

Back Up

In 1894 the UK gov introduced ‘estate duty’, aka inheritance tax, in a bid to raise money to pay off a £4 million gov deficit. It didn’t work – today we have a deficit of £1.9 billion - but they kept the tax anyway.

What is the argument for it?

It’s a tax on top of taxes already paid, so for an individual it is unfair but the argument is that it helps society on the whole by redistributing wealth when a richer person dies.

When does Inheritance Tax have to be paid?

If an individual’s ‘estate’, aka all valuables, think: house, car, savings, investments, business ownership...  is less than £325,000 no tax is charged. If it’s worth more, then anything above £325,000 is taxed at 40%. 

BUT, if a parent or grandparent is passing on a home as part of the estate to a direct descendant (children, step-children or grandchildren) then the allowance is higher, read on. 

The ‘Main Residence’ allowance

If a home is being left to direct descendants then an individual’s zero-tax allowance rises to £450,000. And, the government are planning to increase this by £25,000 a year until it reaches £500,000 in 2020. 

This means married couples can leave a total of £900,000 (rising to £1 million in 2020) to their children or grandchildren without having to pay inheritance tax. 

Tell me more about married couples…

Anything left to a spouse will not be taxed and any unused allowance will be transferred to that spouse. Is that a good enough reason to get married?!

Gimme an example

Mrs and Mr Moneypenny own a £800,000 home, have £200,000 in savings and £100,000 in investments. Their total estate is worth £1,100,000 which they share equally. If Mr Moneypenny dies and leaves everything to his wife, no inheritance tax is paid and Mrs Moneypenny’s allowance rises to £900,000 (two times the individual allowance). 

Mrs Moneypenny wants to leave her entire estate to her children when she dies. In this situation they would receive £900,000 tax free and £200,000 would be taxed at 40%, that’s a £80,000 tax bill! 

Big red flag: If married couples want to leave all or part of their estate to their spouse they must write this in a will. If they don’t, their estate is divided between their spouse and children (or grandchildren) under fixed rules set by the UK Gov. FYI dying without a will is called 'intestacy'. 

What if a parent chooses to divide their estate between spouse and kids?

This can be done but needs planning and they should write a will. It will mean some of their zero-tax allowance is used up and only the remaining amount will be transferred to their spouse. 

Say, using the same example, Mr Moneypenny leaves £100,000 of his savings to his kids and the rest of his estate to Mrs Moneypenny. The £100,000 would be passed on at zero-tax but that leaves only £350,000 of his allowance to go to his wife. His wife’s allowance is now £800,000. 

How to reduce (uhem avoid) paying inheritance tax? 

If your parents’ estate is more than £900,000 and they would like to leave this to you and your siblings they could get stung with a huge tax bill when they die BUT there are ways to reduce this. Same goes if it’s one parent with an estate over £450,000. 

The 7 Year Rule

Money or other valuables, aka 'assets', given away seven years before someone dies are exempt from Inheritance Tax. But they cannot give away assets that they continued to use, like a car or a home. 

In the unfortunate event that someone dies within seven years and their estate is above the tax-free threshold, Inheritance Tax will have to be paid. However, a lower percentage of tax is charged if it has been more than three years. Read more on ‘The 7 year rule’. 

Open a trust

If money, a house, or investments, is placed into a trust which does not benefit the owner, their spouse or any of their children under 18, then the ‘assets’ are no longer part of an estate. A trust can be set-up now or it can be outlined in a will to be set-up after death. It would be wise to seek advice from an expert if this is a route you or your parents want to take. 

Supporting dependents from an income

Parents can use any excess income they have to pay maintenance to an ex-spouse or support their dependents, for example a child’s university fees or their student loan or to support an elderly parent. This money is exempt from Inheritance Tax as long as the payments are from an income – and not from a savings account, the parent’s standard of living is not reduced and the person receiving the money spends it as normal expenditure (rather than stashing it). 

Donate to charity

Anything left to charity is exempt from Inheritance Tax.

Anything else?

The UK Gov don’t make this tax easy to understand, in fact the same goes for all taxes! If you or your parents have a high exposure to Inheritance Tax you may want to consider getting some expert advice which could save you thousands. 

Have a question on Inheritance Tax? Ask MOXI