Inheritance Tax UK: How to Calculate What You Might Owe
Inheritance Tax (IHT) can feel like a complicated puzzle. You know it's a tax on an estate when someone passes away, but how much actually needs to be paid? Understanding the calculation can help you see the potential impact on your own estate or what might be involved if you're an executor.
Let's break down how Inheritance Tax is calculated in the UK, step by step.
Step 1: Value the Estate
The first step is to work out the total value of the deceased person's estate. This includes almost everything they owned:
Property: Their home and any other properties.
Money: Cash in bank accounts, savings, investments, and shares.
Possessions: Cars, jewellery, art, furniture, and other personal belongings.
Proportion of Jointly Owned Assets: If they owned assets jointly with someone else (not a spouse or civil partner where it typically passes to them directly), their share is included.
Gifts Made Within 7 Years: Certain gifts made in the seven years before death might also be added back into the estate's value for IHT calculation purposes (more on this later).
Assets Held in Certain Trusts: In some situations, assets held in trusts from which the deceased benefited might be included.
From this total value, you then deduct:
Debts: Mortgages (unless covered by life insurance paid directly to the lender), loans, credit card balances.
Reasonable Funeral Expenses: The costs associated with the funeral.
The figure you're left with is the net value of the estate for IHT purposes.
Step 2: Apply the Tax-Free Allowances
Everyone in the UK has certain tax-free allowances for IHT. These are subtracted from the net value of the estate before any tax is considered.
Nil-Rate Band (NRB): For the current tax year (2024-2025, and frozen until at least April 2028 - Source: GOV.UK), the NRB is £325,000. This means the first £325,000 of an estate is generally IHT-free.
Residence Nil-Rate Band (RNRB): There's an additional allowance called the RNRB, which is £175,000 for the current tax year (also frozen). This can be used if:
The deceased owned a home (or a share of one).
They pass this home directly to their children, grandchildren, or other direct descendants (including adopted, foster, or stepchildren).
The RNRB is tapered for larger estates: for estates valued at over £2 million, the RNRB is reduced by £1 for every £2 the estate is over this £2 million threshold. (Source: GOV.UK).
Transferable Allowances: A key point for married couples and civil partners is that any unused NRB and RNRB from the first partner to die can be transferred to the surviving partner. This means a couple could potentially pass on up to £1 million IHT-free (£325,000 NRB + £175,000 RNRB, then doubled).
Step 3: Factor in Lifetime Gifts
Gifts made during a person's lifetime can impact the IHT calculation:
Exempt Gifts: Many smaller gifts are immediately exempt (like the £3,000 annual exemption, small gifts of £250, or wedding gifts within certain limits). Gifts to a spouse/civil partner or charities are also generally exempt.
Potentially Exempt Transfers (PETs): Larger gifts made to individuals (e.g., a cash gift of £50,000 to a child) are PETs. If the person making the gift (the donor) lives for seven years after making it, the gift becomes fully exempt from IHT.
Failed PETs (Death Within 7 Years): If the donor dies within seven years of making a PET, its value is added back to the estate for IHT calculation. These "failed PETs" use up the deceased's Nil-Rate Band first, before it's applied to the assets they owned at death.
Step 4: Calculate the Tax
Once you've deducted all available allowances and exemptions from the estate's value (including any failed PETs), you arrive at the amount that is potentially taxable.
The standard Inheritance Tax rate is 40%. (Source: GOV.UK).
Example Calculation:
Let's say a single person dies with an estate worth £600,000. They are leaving their home (worth £300,000) to their child. They made no significant lifetime gifts.
Net Estate Value: £600,000
Allowances:
Nil-Rate Band (NRB): £325,000
Residence Nil-Rate Band (RNRB): £175,000 (as home is left to a child)
Total Allowances: £325,000 + £175,000 = £500,000
Taxable Estate: £600,000 (Net Estate) - £500,000 (Total Allowances) = £100,000
IHT Due: 40% of £100,000 = £40,000
What About Taper Relief on Gifts?
If IHT is due on a gift because the donor died within 3 to 7 years of making it (and the gift, when added to any others, exceeds the NRB), taper relief can reduce the amount of tax payable on that specific gift. It doesn't reduce the value of the gift itself in the estate calculation, but it reduces the tax rate applied to it.
The reduction in tax is:
3 to 4 years before death: 20% reduction (tax rate on gift becomes 32%)
4 to 5 years before death: 40% reduction (tax rate on gift becomes 24%)
5 to 6 years before death: 60% reduction (tax rate on gift becomes 16%)
6 to 7 years before death: 80% reduction (tax rate on gift becomes 8%)
(Source: GOV.UK)
Reduced IHT Rate for Charitable Donations
If at least 10% of the 'net value' of the estate (the value after deducting liabilities but before deducting the NRB/RNRB or other exemptions) is left to a registered charity, the IHT rate on the rest of the estate may be reduced from 40% to 36%.
Who Pays the Tax?
Inheritance Tax is usually paid from the funds in the deceased's estate by the executor (if there's a will) or the administrator (if there isn't). Beneficiaries don't typically pay IHT directly on what they inherit from the estate itself, but they might be liable for IHT on certain lifetime gifts they received if the donor died within 7 years and there isn't enough in the estate to cover it.
It Can Be Complex
While this gives you a good overview, calculating IHT can become very complex, especially with multiple gifts, trusts, or business/agricultural assets involved.
Need clarity on a potential Inheritance Tax situation? Working out potential IHT liabilities can be tricky. If you're an executor or planning your own estate and want to understand the potential IHT implications, we invite you to book a call with one of our trusted financial advisers. They can provide personalised calculations and guidance.
Important Disclaimer: The information provided in this article is for general informational and educational purposes only, and does not constitute financial advice. Everyone's financial situation is unique, and what may be appropriate for one person may not be for another. We strongly recommend that you seek personalised advice from a qualified and FCA (Financial Conduct Authority) approved financial adviser before making any financial decisions or taking any action based on the content of this article.
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