Your inheritance tax bill could be thousands of pounds, but when do you actually need to pay it? There are many ways to keep an inheritance tax bill in check and some situations where you might not have to pay it at all.
Inheritance tax is a tax on the estate of a deceased person. The estate, which consists of the property, money and possessions of the person, is valued after death and divided among any heirs. You might have to go through a process called probate before you can divide the estate and the process often requires you to pay inheritance tax.
How much tax you need to pay depends on the value of your estate. We’ve written a guide on estimating an estate's value previously, and it can give you useful tips on preparing for inheritance tax. But let's turn our attention now to questions regarding when you need to pay the tax.
When do you not pay inheritance tax?
It's a good idea to start with the clear-cut rules around when you don't have to pay inheritance tax. There's usually no inheritance tax if:
- The value of the estate is below the £325,000 threshold
- You leave everything above it to your spouse, civil partner, a charity or a community amateur sports club
If you decide to give your home to your children, then the threshold can increase to £500,000.
Can you transfer the unused threshold to your partner?
You can pass your unused threshold to your partner when you die. This could increase their threshold to as much as £1 million in the tax year 2020/21.
Scenario: Couple (married but could also be a civil partnership)
Value of family home: £800,000
Additional assets: £200,000
Total combined assets: £1 million
Inheritance Tax Allowance: £325,000 each
Residence Nil Rate Band (RNRB): £175,000 each
Combined allowance: £500,000 each
If you were to die before your wife, leaving your share of your joint estate to her, there would be no inheritance tax (IHT) to pay. This is because inter-spouse/civil partner transfers are exempt from IHT - leaving your wife with assets valued at £1 million.
If your wife was to die in the tax year 2020/21, with the intention of leaving the family home to her children, she could claim unused allowances from your death. Including her own allowances, she (or more accurately, those inheriting her estate) would be entitled to claim:
IHT allowance x 2 = £650,000
RNRB allowance x 2 = £350,000
Total allowance = £1m
Therefore, as long as she left the family home to her children, an estate of £1 million would not attract any inheritance tax.
When it comes to the RNRB allowance, the element transferred is based upon the percentage unused after the first spouse or civil partner's death. If at the time of their death the maximum (unused) RNRB allowance was £100,000 this would equate to 100% of any future allowance band.
If the allowance had increased to £150,000 before the second spouse or civil partner's death, they would be entitled 100% of the increased allowance. Conversely, if 50% of the RNRB had been used, this would equate to a transfer of 50% of the current allowance; £75,000 in this instance.
If your estate was worth £162,500, it means you didn’t use 50% of your tax-free allowance. Your partner would then inherit the 50% on top of their threshold. If the threshold remains at £325,000, their allowance would be £487,500 plus the additional threshold to leave the property to children.
How much tax do you have to pay?
Anything above the £325,000 threshold is subject to inheritance tax, barring a few exemptions. The current standard inheritance tax rate in 2020 is 40%. It’s only charged on the part above the threshold.
If your estate is worth £500,000, your tax-free threshold is £325,000. Your estate pays inheritance tax on the £175,000 that’s above the threshold.
Who pays inheritance tax?
But who has to pay the bill? The estate also pays any tax due on your estate. The person dealing with the estate will make sure the tax payment is made from the estate on time.
The exception to this is tax due on gifts. If there is any tax due on gifts you made in the previous seven years, the recipient is usually in charge of paying tax. If they can’t or they won’t, the money will come out of your estate.
Can you pay inheritance tax in advance?
You can't make a payment before you've died. You should prepare for possible payments by estimating your estate's value and figuring how much tax your beneficiaries might have to pay. But you're not allowed to pay a tax bill before the person in question has died.
You can make payments without knowing exactly how much you have to pay. These are called ‘payments on account’. If you know you have to pay tax, then making a small payment in advance like this can help move the process along.
How soon do you have to pay inheritance tax?
You have to pay inheritance tax within six months after the person died. If you died in January, your estate must deal with any tax payments by the end of July. If you fail to make the payment, HMRC will charge interest on the tax bill.
It’s also worth noting here that you usually have to make at least a partial payment before you can go through the probate process.
To pay, you’ll need to get a payment reference number from HMRC. You can find more information about it here.
Do you have to pay it all at once?
You do not have to pay the whole inheritance tax at once. Instalments are available for:
- Shares and securities, including unlisted shares and securities
- Business run for profit
- Agricultural land and property
You have to pay the first instalments within the six months. Later payments are then due every year on the date you made the first payment. You can pay in annual instalments over ten years. Please note that HMRC will charge interest on these payments.
Can you pay with the estate’s bank account?
Since the estate is in charge of paying the inheritance tax, you can make the payments using the deceased's bank accounts or government stock. You need to ask the banks, building societies, or National Savings & Investment account to pay through the Direct Payment Scheme scheme.
To do this, you need to ask the bank to make you a personal representative. Each bank will have different requirements and procedures for this, so contact the bank for more information. You also need to fill specific forms and can find out more about these from the government website.
You may require probate to use certain accounts which can complicate things. It’s worth noting that if you have life insurance in a trust, your estate can use this money to foot the bill without having probate.
What if you can’t use the estate’s bank accounts for payments?
If you find yourself in a situation where you are dealing with an estate and you can’t use the money to make the payments, you have to pay inheritance tax from your bank account. You can then claim the money back from the estate or the beneficiaries once you go through the probate process. You need to provide a receipt of the IHT payments you've made to the estate. Once probate is done, you can pay back any IHT payments before dividing the rest of the assets. If you've overpaid to HMRC, you need to write to HMRC to claim back the money.
When do you pay inheritance tax?
In conclusion, you pay inheritance tax when the estate is above certain thresholds. The threshold currently is at £325,000. You can increase this to £500,000 if you leave your property to children and your partner can use your unused threshold.
You need to make the first payment within six months. While the money to pay the tax bill should be taken from the estate, you might have to make the payments using your own money. You can always claim the money back from the estate. The process to pay is simple enough but it is a good idea to understand if you need to pay inheritance tax. It will help you prepare for the possible payments in advance.