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5 myths about inheritance tax

Inheritance tax is one of the most discussed taxes in the UK. While inheritance tax divides opinion, many aspects of it are still shrouded in mystery and myth. There are several persistent myths people continue to hold on to when it comes to inheritance tax.

5 myths about inheritance tax
Krista Lomu
· 7 min read

Inheritance tax is one of the most discussed taxes in the UK. While inheritance tax divides opinion, many aspects of it are still shrouded in mystery and myth. There are several persistent myths people continue to hold on to when it comes to inheritance tax.

What are the most common, and what should you know about them?

Myth #1: I can give away my money to avoid the tax

Inheritance tax is a tax on the assets you leave behind when you die. Many people think you can avoid it by giving away your money before you die. The thinking is relatively straightforward. If you give away your money, then you aren't leaving anything behind to tax, right?

However, inheritance tax doesn’t quite work that way. As you might have read in our previous post, anything you’ve gifted away seven years before your death could be subject to tax. You can gift each year tax-free up to £3,000. But anything above this sum could attract inheritance tax after you die. Therefore, you can’t start gifting away your estate without considering inheritance tax in the final years of your life.

Myth #2: My spouse is going to inherit everything I leave behind

Another dangerous myth is to assume your spouse or civil partner is automatically going to inherit everything. Sometimes people seem to believe you just have to be in a committed relationship to pass on your assets to your significant other. In addition to this, the myth often claims the new exemption means you also don’t need to pay any inheritance tax on the things you leave to your partner.

At the moment, each spouse or civil partner will have an inheritance tax allowance of £325,000. Recent changes have seen the creation of an additional tax-free property allowance of £175,000. However, this is only applicable for those leaving their home to a direct descendant. This includes:

  • Children
  • Grandchildren
  • Great-grandchildren
  • Stepchildren
  • Adopted children
  • Foster children

Upon the death of a spouse/civil partner, the surviving individual can claim any unused inheritance/property tax allowance. In theory, upon their death, they could have accumulated a combined inheritance/property tax allowance of up to £1 million. The split is as follows:

  • 2 x £325,000 (standard inheritance tax allowance) = £650,000
  • 2 x £175,000 (property-related inheritance tax allowance) = £350,000

So, if the surviving spouse were to leave an estate valued at £1 million, including a £350,000 family home, to their children, there would be no inheritance tax to pay.

The truth is different, and you should know the rules are different for married and unmarried couples. The first thing to note is that unmarried couples don't enjoy the exemption. If you aren't married or in a civil relationship, your partner will not enjoy the inheritance tax exemption! 

Who inherits your estate depends on whether you have a will or not. If you don’t, your estate will also pass on with the law of intestacy in England and Wales. This means your estate will go to a surviving spouse or civil partner but also to your children. Your children will automatically inherit a portion of the estate, and this portion will trigger an inheritance tax charge.

The best way to guarantee your estate goes to your spouse or partner in full, or to anyone you want to inherit your assets, is to write a will. A will is the only way to guarantee your money and assets are divided as you wish.

Myth #3: I can give my home to my children tax-free

When it comes to passing on your home, many persistent myths remain. People often think they can pass on their home to their children and avoid inheritance tax. It’s even thought you could continue to live in the house and still avoid inheritance tax at the time of your death.

Again, it’s important to remember the transfer of property would be considered a gift. If you die within seven years of gifting your home, then the property would be subject to a gift tax. Furthermore, you also have to understand the concept of Gift with Reservation of Benefit (GROB) when it comes to properties. GROB is a situation where you give a gift but retain some use or benefit of it. If you give your property and continue to live in it, the property would be considered a GROP. This means it wouldn’t fall under the seven-year rule. The full value of the property would be counted towards your estate and be subject to inheritance tax.

You can apply the seven-year rule by turning the property into a gift by moving out from it and not benefitting from it financially. It’s also possible to continue living in it and pay the child rent at the market rate. It’s important to note it has to be market-rate – if you pay a cheaper rate, you’re benefitting from the property.

Of course, you might not have to pay inheritance tax if your estate (including the property) is below the inheritance tax threshold. If you leave the property to direct descendants, you enjoy an extra £175,000 on top of your regular £325,000 tax allowance, meaning you can leave behind a property worth under £500,000 tax-free.

Myth #4: I can’t gift above £3k per tax year without inheritance tax

Gifts and inheritance tax count for many myths. Another one is the idea you can’t gift above the £3,000 threshold without attracting inheritance tax. The thinking is that if you gift away more than this, then you have to start paying taxes. A threshold can often seem like it is immediate and enforceable.

However, there are no rules to how much you can gift in any given year. The threshold simply means you are free to gift £3,000 each year, without inheritance tax. Even if you die within the next seven years, those gifts under £3,000 won't count towards your estate. Anything above it, however, will. But inheritance tax is only ever applied after you have died.

Myth #5: I won’t have to pay inheritance tax if I move abroad

People also believe they can avoid the tax if they move away from the UK. Similarly, many seem to think assets abroad are not subject to inheritance tax in the UK.

The truth is you can’t run away from inheritance tax. Your tax liability depends on your UK domicile status. It depends on when you last lived in the UK and where your permanent home is at the time of death. The problem is that many think their domicile status changes simply because they move abroad. This is not the case, and you can find out more about your tax liability from our previous post. It’s also worth noting that your non-UK assets might count towards your estate when you live in the UK.

Don’t fall for inheritance tax myths

Many of the above myths could be harmful to you and your loved ones. If you believe them and don’t properly prepare for your inheritance, your family might end up paying a lot more in tax. It’s essential to learn about inheritance tax and how it works. You should start thinking about your inheritance tax, estimating your estate’s worth and consulting tax experts if you are unsure about anything surrounding the topic. Proper preparation gives you peace of mind and helps your family out as well.

Krista Lomu
Krista Lomu
Krista has been writing about finance for nearly a decade. Based in London, she hopes to turn even the most complicated topics to approachable and interesting for readers. When she's not writing and working with small businesses, she likes to read, watch football and play games - fuelled on by many cups of coffee!
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