What is the inheritance tax threshold and how does it work?

INHERITANCE tax may not be the most riveting of topics but paying attention to the rules and regulations could very well save you a fortune when you die.

Here’s everything you need to know about inheritance tax – including the threshold limit.

There are legal ways to lower your inheritance tax billCredit: Alamy

What is inheritance tax?

Inheritance Tax is a tax on the estate – the property, money and possessions – of a person who’s died.

There’s normally no Inheritance Tax to pay if the value of your estate is below the £325,000 threshold.

And you can avoid paying the tax if you leave everything above the threshold to your spouse, civil partner, a charity or a community amateur sports club.

If your estate’s value is below the £325,000 limit, you will still need to report it to HMRC.

If you give away your home to your children – including adopted, foster or step children – or grandchildren when you die, your Inheritance Tax threshold can increase to £500,000. This is called the “main residence” band.

If you’re married or in a civil partnership and your estate is worth less than the upper limit, any unused threshold can be added to your partner’s when you die.

This means their threshold can be as much as £1million.

The standard Inheritance Tax rate is 40% – but it is only charged on the part of your estate that’s above the threshold.

How does the ‘main residence’ band work?

The main residence band is an additional nil-rate band introduced when you pass your home onto a direct descendant.

In 2020/21 the maximum that can be passed on tax-free is £1million for married couples or those in a civil partnership, £500,000 for others.
For singles, this is made up of the existing £325,000, plus an extra £175,000. For couples, when the first one dies their allowance is passed to the survivor, so that £500,000 is doubled to £1million.
On estates worth between £1million and £2million, inheritance tax will be paid as normal on the amount above the tax-free amount.
On estates worth £2million or more, homeowners will lose £1 of the “main residence” allowance for every £2 of value above £2million. So for a couple, properties worth £2,350,000 or more will get no additional allowance.

Source: Money Saving Expert

Legal ways to get around inheritance tax

If you leave 10 per cent or more of the net value of your estate to charity in your will, there is a reduced rate of 36 per cent on some assets.

You can also give gifts while you’re alive, however these will be taxed if more than £325,000 is handed out in the seven years before your death.

There’s usually no Inheritance Tax to pay on small gifts you make out of your normal income, such as Christmas or birthday presents – known as ‘exempted gifts’.

There’s also no Inheritance Tax to pay on gifts between spouses or civil partners. You can give them as much as you like during your lifetime, as long as they live in the UK permanently.

Putting assets into a trust for your heirs as well as paying into a pension instead of a savings account, will also help reduce inheritance tax.

There are other reliefs too, such as business relief and agricultural relief where some assets can be passed on tax free.

Who pays the inheritance tax?

Funds from your estate are used to pay the tax and this is done by the executor of the will – the person dealing with the estate after the person has died.

You might have to pay inheritance tax on gifts you have received before the person dies.

This would only come into force if the person gave away more than £325,000 and died within seven years of giving the gift.

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This post first appeared on thesun.co.uk