Ask the Expert: How does inheritance tax work?

Carl Lamb on Inheritance Tax Allowances

Carl Lamb on Inheritance Tax Allowances - Credit: Smith & Pinching/Getty

This week our reader wants to know how inheritance tax works. 

Reader question: 

My parents are in their early 80s and in good health.

They are quite wealthy but are not in the habit of talking to us – their three children – about money matters.

My dad said recently that he didn’t think there would be any inheritance tax to pay when they die but I’m concerned he might be wrong. Can you explain how inheritance tax works please?

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Carl Lamb of Smith & Pinching responds: 

I’m always surprised at how little is known by the general public about inheritance tax (IHT) rules. The good news is that the vast majority of estates won’t have an IHT liability, but it is always good to check specific cases to be certain.

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The amount you can leave to your heirs without incurring IHT varies according to your circumstances, but let me summarise the main points of the exemptions involved.

Firstly, couples and civil partners can leave their estate to the surviving partner free of IHT. It’s important to note, however, that co-habiting couples are excluded from this rule.

Every UK resident has a standard IHT exemption – known as the Nil Rate Band – of £325,000. On top of that, if the deceased is leaving the value of the family home to their direct descendants (children, grandchildren, adopted children, stepchildren and fostered children), they get an additional slice of exemption of up to £175,000 depending on the value of the house – or their share in it. This is known as the Residence Nil Rate Band.

Being married or in a civil partnership has an additional benefit: any unused Nil Rate Band and Residence Nil Rate Band on the death of the first partner can be passed to the surviving partner.

This means that a couple who leave everything to the surviving partner on the first death then leave the value of the family home to their direct descendants on the second death can benefit from a total IHT exemption of up to £1 million, depending on the value of the home.

However, particularly with rising property prices, there are still many estates that will exceed £1 million. If this is the case for your parents, then I strongly recommend that they take independent financial advice.

IHT can be mitigated in a number of different ways such as lifetime giving, family trusts and charitable bequests.

In addition, there are plans and policies available such as discounted gift trusts that give an immediate reduction in the value of the estate but provide an income.

Any opinions expressed in this article do not constitute advice. They assume the 2021/22 tax year and may be subject to change.

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