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How inheritance tax is calculated

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See what steps you can take to mitigate your tax

using this easy to follow Inheritance Tax (IHT) guide

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How Inheritance Tax is Calculated in the UK

Inheritance Tax

Inheritance tax is calculated on the total assets you leave behind at the time of death. It is the tax levied on profits and income from the inherited property.

It is possible to minimize inheritance tax with the help of the right practices. For example – you can increase the nil band which increases the value of nontaxable assets at the time of death.

The more assets you leave behind, the more inheritance tax your beneficiaries will have to pay. Enlist the help of a reputed estate planning company to plan your inheritance tax.

Inheritance Tax Calculation

How It Works

Your inheritance tax is calculated on the total assets at the time of death. These assets are calculated after subtracting debt and liabilities owed.

The inheritance tax is calculated at 40% of the total estate above £ 325,000

The Rate Nil Band

Residence Nil-Rate Band

The nil rate band of the inheritance tax is set at assets worth £325,000. This means that if your asset valuation is below the nil band, you do not have to pay any inheritance tax.

It is possible to increase the nil rate band by adding the residence nil rate band to this amount. The residence nil band is set at £175,000.

The total nil band now becomes £500,000, which makes it easier to avoid inheritance tax in the UK.

Reducing Inheritance Tax

You can further reduce inheritance tax by

A reputed inheritance tax adviser can help you minimise tax. They can also help you calculate your assets and reduce the taxable threshold.

The 7-Year Rule

Avoid Inheritance Tax

Your heirs will owe no taxes on gifts that you give away before 7 years of your death. This is the 7-year rule.

If you die within 7 years then there is tax, but on a scale called the Taper Relief.

Years between Gift and Death Rate of Tax on the Gift
3 - 4 years 32%
4 - 5 years 24%
5 - 6 years 16%
6 - 7 years 8%
7 or more 0%

Gifts given in the last 3 years before your death are taxed at 40%

Anyone can calculate inheritance tax. You need to provide substantiating documents to the HMRC.

Your estate executor will take care of the paperwork for you.

Paying Inheritance Tax in the UK

Residence Nil-Rate Band

You can pay inheritance tax in the UK to the HMRC within 6 months of receiving your inheritance.

The HMRC (HM Revenue and Customs) is the UK’s tax, payments, and customs authority. They are the regulatory body for UK’s public services.

Can You Pay Inheritance Tax out of the Inherited Estate?

Avoid Inheritance Tax

Ideally, you should be able to pay the inheritance tax out of the estate, but sometimes if the inheritance tax calculation goes wrong, you could end up with more taxes than you can afford.

In the worst-case scenario, your heirs may even have to take a loan to pay off the inheritance tax.

Ensure that you plan your estate well in advance to avoid such mishaps.

Estate Planning for Calculating Inheritance Tax

Inheritance Tax

Reduce inheritance tax through proper estate planning. 

Estate planning can be tricky, and you need to update your estate planning documents every time you add assets to your estate.

Legal Instruments for Estate Planning

There are two primary legal instruments for estate planning.

These instruments have different functions and uses. Wills are executed after death whereas trusts can be in use before death.

Use a mix of these instruments for the best results.

Special Considerations when Calculating inheritance Tax

Keep enough to live on rather than giving it all away. While estate planning is important, you need to have a good life as well.

The UK government states that your estate planning need not be too stringent and you must not compromise on your standard of living just to plan your inheritance tax.

You need to have a proper mix of your estate in trusts, wills, and gifts. Maintain a balance in your estate when you pass on your assets, with proper timelines.

Conclusion

It is not difficult to calculate inheritance tax, but there could be many things you might miss when you’re planning your estate. 

Go through a reputed company that has been in the business for years. They will understand the nitty-gritties of calculating inheritance tax and help you find more ways to save inheritance tax.