Your guide to Inheritance Tax

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Inheritance Tax can be confusing – especially when probate is involved. If you're dealing with a loved one's estate or planning ahead, it's important to understand how and when Inheritance Tax must be paid, and what steps you can take to reduce it. In this article, discover what inheritance tax is and effective methods to reduce your liability.

What you'll learn:

What is Inheritance Tax?

Inheritance Tax is a charge on the estate of someone who has died. This includes their property, money and belongings. The tax has existed in the UK for a long time – it first appeared in 1694 as ‘Probate Duty’.

How much is Inheritance Tax?

Today, Inheritance Tax applies to estates worth more than £325,000. Anything above this amount is usually taxed at 40%. 

Example: If your estate is worth £400,000, tax is charged on the £75,000 above the threshold. That means you’d pay £30,000 in tax.

Keep in mind that tax rules can change.

There are some exceptions. If you leave anything to your spouse or registered civil partner, no Inheritance Tax is due. But if you leave assets to someone else, it usually counts towards your estate and may be taxed.

Your tax-free threshold can rise to £500,000 if you leave your home to your children or grandchildren. This includes adopted, foster or stepchildren. The higher threshold applies if your estate is worth less than £2 million, after which it tapers off.

Who pays Inheritance Tax?

The person dealing with the estate will pay the Inheritance Tax. If there’s a will, they will be the ‘executor’. Your beneficiaries (the people who will inherit your estate) do not normally pay Inheritance Tax on what they inherit.

When do you pay Inheritance Tax?

Inheritance Tax must be paid by the end of the sixth month after the person dies. If it isn’t paid on time, HMRC will charge interest. This means you’ll end up paying more.

Executors can choose to pay Inheritance Tax on certain assets, like property, in instalments over ten years. But it’s a good idea to pay some of the tax within the first six months. This is called a ‘payment on account’. It helps lower the interest, even if the estate hasn’t been fully valued yet.

How to reduce Inheritance Tax

There are a few ways you my be able to lower your Inheritance Tax bill. These depend on your personal situation, so it’s a good idea to speak to a tax expert for advice that’s right for you.

1. Ensure you have a will

Writing a will is one of the easiest ways to make sure your estate goes to the people you care about when you die. Without a will, the UK Government rules decide how your assets are shared. Saga Legal offer a free legal review that can help make sure your needs are fully protected.

A will can also help reduce your Inheritance Tax. For example, you can choose to leave gifts to charities, which will be exempt from Inheritance Tax. If you leave enough, you may even qualify for a reduction in the Inheritance Tax rate from 40% to 36% on the gifts that aren’t going to charities.

2. Spend your money

As we get older, we often spend less. Spending or gifting your money can help reduce Inheritance Tax, since savings and investments are taxed when passed on.

If you’re financially secure, now is a great time to enjoy your money and support your family. This could mean paying for a meal out, or booking a spa trip. If you have larger savings, you might gift money to help your children or grandchildren buy a car, get married, or put down a deposit on a home.

Buying a first home is harder than ever. House prices are rising faster than wages, and it now takes the average buyer 8 years to save a deposit. Research from Tembo Money shows that one in four young adults may inherit more than they earn in 40 years. But most won’t receive this inheritance until their 40s or later – making home ownership a long wait.

Gifting money earlier can help your loved ones buy a home sooner and start building their own property wealth. It could also lower the Inheritance Tax on your estate.

If you give a gift and live for at least 7 years, the gift won’t be taxed when you pass away. For example, gifting £100,000 could save your family £40,000 in Inheritance Tax.

If your wealth is tied up in your home, you could use a Deposit Boost or Lifetime Mortgage to unlock funds. This lets you gift money from your property to help a family member with their deposit – possibly allowing them to buy years earlier.

3. Take out life insurance

Taking out a life insurance policy which covers an Inheritance Tax bill is another way to reduce the liability on your estate. If you put the policy in a trust, this ensures it will be paid outside of your estate on your passing.

4. Give generously

You can reduce Inheritance Tax by giving money away. For example, you can transfer assets to your husband or wife without paying tax. You can also use the annual £3,000 gift allowance to give money to loved ones. If your child is getting married, you can gift up to £5,000 tax-free, and for a grandchild it is up to £2,500.

Donations to charities and political parties are also tax-free. You can make donations during your lifetime or include them in your will.

If you want to lower your Inheritance Tax and help your child or grandchild buy a home, Saga Mortgages can support you. Our partner Tembo is an award-winning digital mortgage broker. They help first-time buyers increase their borrowing power, including through family-supported options.

Be careful of the 7-year rule

Giving to your loved ones before your death can be an effective way to reduce the Inheritance Tax liability on your estate, but there are some rules to be mindful of. One key rule is that you must not continue to benefit from the gift after it has been made. For example, if you gift a property but carry on living there rent-free, the value of that property will remain in your estate for Inheritance Tax purposes. This is known as the ‘gift with reservation of benefit’ rule.

In addition, gifts given less than seven years before you die may be subject to tax, depending on who you give the gift to, the value of the gift and when the gift was given. This is known as the 7-year rule.

Any gifts you make in the seven years before your death will reduce your available nil rate band (currently £325,000, or up to £650,000 if you have a transferable allowance from a spouse). These gifts are applied in chronological order. If the total value of gifts during that period is less than your available nil rate band, no tax will be due on those gifts. 

If the gifts exceed the nil rate band, the excess amount may be subject to Inheritance Tax. Taper relief can reduce the tax rate on gifts made between three and seven years before death, but it only applies   to the tax due on the portion given above the nil rate band.

Taper relief

Years between gift and death Effective rate on gifts after taper relief applied to tax due

3 to 4 years

32%

4 to 5 years

24%

5 to 6 years

16%

6 to 7 years

8%

7 years or more

0%

Do you have to pay Inheritance Tax before probate?

Generally speaking, in order to get a grant of representation (or probate), unless eligible for the instalment option, you need to pay towards any Inheritance Tax that’s due. There are multiple ways to do this, but if you choose to pay out of your personal bank account, you can claim tax back from the estate.

How to pay Inheritance Tax before probate

Inheritance Tax usually needs to be paid before you can get a grant of probate. If the estate doesn’t have accessible funds right away, there are a few ways to cover the tax in the meantime:

  • Direct Payment Scheme (DPS). This lets banks and building societies pay Inheritance Tax directly from the deceased’s account.
  • Grant on credit. HMRC may allow probate to be granted before full payment if certain conditions are met.
  • Short-term loans. Some banks or probate specialists offer loans to cover the tax until the estate assets can be released.
  • Personal funds. In some cases, executors or beneficiaries may choose to pay the tax upfront and be reimbursed later from the estate.

What is the Direct Payment Scheme and how does it work?

A Direct Payment Scheme is a government program which lets you pay Inheritance Tax from the deceased’s bank or building society account. The scheme has also been extended to include the deceased's investment accounts, although not all investment providers have signed up to use it. So, make sure you check their terms.

Can you get a grant on credit from HMRC?

If you can’t get money from the estate before probate is granted, HMRC might let you delay paying Inheritance Tax. This is called a grant on credit.

To get one, you must ask HMRC. They may agree to wait until you receive the grant of probate. Once you have it, you must pay the tax straight away or within a timeframe agreed with HMRC.

You can only apply for a grant on credit if there’s no other way to access money from the estate.

How much Inheritance Tax must be paid before probate?

Before probate is granted, HMRC usually asks you to pay some of the Inheritance Tax. In most cases, this means paying tax on things like money in bank accounts, shares or personal items – not land or property.

If the estate includes property, you might be able to pay the tax in instalments over 10 years. But you’ll still need to pay the first instalment before probate is granted.

HMRC will tell you how much needs to be paid once you’ve sent in the right forms. If you’re not sure, it’s a good idea to speak to a probate expert or contact HMRC directly. 

Which Inheritance Tax form do you need for probate?

If Inheritance Tax is due, or if the estate doesn’t count as an ‘excepted estate’, you’ll need to fill in form IHT400. Saga Legal's probate advice can support you through each step of the probate process with clear and simple advice.

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