Regardless of whether you live inside or outside of the UK, you likely know about the impact inheritance tax in the UK might have on your future finances. Fortunately, inheritance tax in the UK only affects a proportionally small number of estates, so there’s a good chance you won’t be impacted by it.
However, if you are set to inherit the estate of a close relative who has passed away, and their estate falls into the taxable category, then it can be useful to know how inheritance laws work so you can avoid paying unnecessary fees.
In order to help you wrap your head around this sometimes complicated process, we’ve broken down everything you need to know about UK inheritance taxation to make the process as simple and stress-free as possible.
What Is Inheritance Tax?
In layman’s terms, inheritance taxation is a tax that is levied on the inherited wealth left to you by a specific individual upon their death, according to where they bequeathed their estate and how much has been bequeathed to each beneficiary.
The estate of said individual is a combination of all of their accumulated wealth and assets, and if it reaches a certain allowance threshold, a tax will be levied on it. What falls under an estate can include, but is not limited to, the following:
- Shares and investments
- Personal possessions
- Insurance pay-outs
- Jointly owned assets
Only after any necessary tax on inheritance has been paid can an estate’s assets be distributed to the requisite beneficiaries, so it is vital that you pay this tax as soon as possible to release the estate into your possession and prevent it from being claimed by the government.
Who Pays Inheritance Tax?
Under UK law, the individual who covers the payment of this specific tax will always be the executor of the deceased’s will, or the administrator of their estate if no executor is stated.
As a result, you won’t necessarily pay tax on what you inherit directly from your accounts. Instead, the cost of the tax will be taken from the estate’s overall value after the tax-free threshold.
Why Do You Pay Inheritance Tax In The UK?
The main idea behind the tax is to prevent the accumulation of wealth upon the death of an individual. Instead, some of the wealth is redistributed to the state, ensuring that it can be directed towards projects and services that benefit everyone in the country.
Laws Surrounding UK Inheritance Tax For Non-Residents
Even if you’re not a direct resident of the UK, there is a chance that you may have to pay this tax upon the death of a relative. This clause is most commonly invoked when receiving UK property or land, however, you will only pay this tax if you choose to sell the land or property and you make financial gains from its sale.
For other estate assets, laws on UK inheritance tax for non-residents specifically state that you won’t be taxed on these unless they breach your allowance limit.
Inheritance Tax Laws For UK Expats
Naturally, inheritance tax also affects expats living outside of the UK whose domicile remains inside the UK territory. Changing your domicile will mitigate this, however, the process to do so is not easy, and is not simply a case of proving that you no longer reside in the UK.
The UK tax system requires proof that you do not intend to return to the UK before they can strike you from the tax list, and even then, you’re still liable to pay tax on inheritance if you continue to own UK-based assets.
What Is The Inheritance Tax Threshold In The UK?
As we’ve previously mentioned, although this tax can be levied on an estate, the value of said estate must first pass the inheritance tax allowance in the UK set by the government.
The current allowance threshold is set at £325,000, though this cut-off point can be increased to £500,000 if the individual that died owned, or part-owned, their home, or if they have bequeathed this home to their child, foster child, stepchild, or grandchild.
Unfortunately, once an estate passes the value of the inheritance tax allowance in the UK, a percentage of payment will then be levied on any remaining wealth after the allowance threshold.
And the payment of this tax doesn’t end there. Should you look to disperse the estate further after initial taxes on inheritance have been levied, you will be required to make further tax payments should you provide gifts worth more than £3,000 in total.
What Are The Different UK Inheritance Tax Rates?
As with many taxes, there are a variety of rates than can be applied to inheritance tax. In the UK, the base rate of this tax is set at 40%, regardless of the contents of the estate in question.
However, the good news is that this percentage rate will eventually taper off for future gifts, disappearing entirely seven years after the owner of the estate’s death.
Below are the different percentage rates based on this seven-year period:
|Period of time between gift and death||Tax rate|
|Less than 3 years||40%|
|3 to 4 years||32%|
|4 to 5 years||24%|
|5 to 6 years||16%|
|6 to 7 years||8%|
|7 or more years||0%|
What Are The Inheritance Tax Exemptions?
While many people will end up paying this tax in some capacity, there are a few exemptions that can reduce or eliminate this requirement.
First and foremost, if the deceased leaves the entirety of the wealth above the inheritance allowance threshold to their spouse or civil partner, no tax is payable.
Additionally, if an individual dies and their estate is worth less than their tax allowance, any remaining allowance can be added to their spouse or civil partner’s allowance, making the maximum possible threshold up to £1,000,000 per couple if the family home is bequeathed to a child, foster child, stepchild, or grandchild.
On top of this, no inheritance tax is payable if all wealth above their allowance is bequeathed to a charity or community amateur sports club.
Taxation And Gifts
As we’ve previously mentioned, it is still possible to pay further tax even after the initial tax payment has been made, if you choose to divide the estate up as gifts.
Every individual in the UK has what is known as an annual gift allowance, which means that up to £3,000 worth of assets or cash can be given away each year without being considered for inheritance tax. Any excess wealth is then taxed.
However, some gifts are exempt from being included in the annual gift allowance, allowing them to be gifted without any additional payment. This includes any of the following gifts:
- Gifts worth £250 or less to an individual who has not already received a gift from your annual gift allowance.
- Wedding gifts up to £5,000 for their child, £2,500 for grandchildren, and £1,000 for a relative or friend.
- Gifts to help pay for the cost of living of an ex-spouse, an elderly relative, or a child under 18 who is in full-time education, depending on the circumstances.
- Gifts to a charity or community amateur sports clubs.
- Gifts to political parties, depending on the circumstances.
- Gifts from surplus income, depending on the circumstances.
It’s important to remember that gifting and tax is a complex area with complex rules, so it’s important that you keep a detailed record of gift payments if you intend to take advantage of this particular mechanism. As always, it’s best to consult a qualified professional if you’re at all unsure.
As we mentioned right at the start, there is a good chance that you may not have to deal with inheritance tax at all during your life. However, if you do, having the knowledge of how such tax mechanisms work will be essential to getting the most out of your inherited wealth.
And here at Blacktower, we don’t just deal with UK inheritance laws. Instead, we work with expats in all the countries we operate in to help them get the most out of their tax planning and financing. For example, why not take a look at our piece on Spanish inheritance tax if you’re planning on moving there?
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Disclaimer: The above information was correct at the time of preparation and does not constitute investment advice. You should seek advice from a professional regulated adviser before embarking on any financial planning activity.