Your inheritance tax bill could be thousands of pounds, but when do you 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. Understanding how the tax works can help you organise your affairs and reduce the stress on your loved ones.
Inheritance tax (IHT) is a tax on the estate of a deceased person. The estate, which consists of the deceased’s property, money, and possessions, 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 IHT.
The value of the deceased person’s estate determines the amount of tax to pay. We’ve written a guide on estimating an estate's value previously, and it can give you valuable tips on preparing for IHT.
We spoke to Tom Bradfield at law firm Clarke Wilmott, who told Pension Times: "More and more people are rightly concerned about the potential impact of inheritance tax on their families. The truth is that the majority of estates pay no tax at all because of the exemptions and allowances. There are sharks out there selling complicated schemes which they claim will protect families from inheritance tax and local authority care fees.
"Although they can be “reassuringly expensive”, in many cases these products are inappropriate and can even result in more tax being due. If it sounds too good to be true, it probably is. Make sure you speak to a regulated professional such as a solicitor or chartered financial advisor to get advice you can rely on."
Let's turn our attention 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 IHT. There's usually no inheritance tax payable if:
- The value of the estate is below the £325,000 inheritance tax threshold
- You leave everything above the inheritance tax threshold to your spouse, civil partner, a charity, or a community amateur sports club
If you decide to give your home to your children, the threshold can increase to £500,000 if the total value of your estate is less than £2 million.
Can you transfer the unused threshold to your partner?
Married couples or civil partners can pass their unused threshold to the surviving spouse. At the time of writing, the threshold could increase as high as £1 million.
Scenario: Couple (married or in 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 spouse or civil partner, leaving your share of your joint estate to them, there would be no IHT to pay. This is because inter-spouse/civil partner transfers are exempt from IHT - leaving your partner with assets valued at £1 million.
If your spouse was to die in the tax year 2022/23, with the intention of leaving the family home to their children, they could claim unused allowances from your death. Including their own allowances, they (or, more accurately, those inheriting their estate) could claim:
IHT allowance x 2 = £650,000
RNRB allowance x 2 = £350,000
Total allowance = £1m
Therefore, as long as they left the family home to their children, an estate of £1 million would not attract any IHT.
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 to 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 IHT, barring a few exemptions. The current standard inheritance tax rate in 2022 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 IHT on the £175,000 that’s above the threshold.
Who pays inheritance tax?
The estate is liable for any inheritance tax. Therefore, the person dealing with the estate must ensure the tax payment is made from the estate on time.
The exception to this is tax due on gifts. If any tax is due on gifts made in the previous seven years, the recipient is usually responsible for paying the tax. If they can't or refuse to pay, 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. However, you can prepare for possible IHT payments by estimating your estate's value and determining 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. If you see anyone offering you options to do so, these are scams!
You can make payments without knowing exactly how much you have to pay - '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 IHT within six months after the person dies. So, for example, if you die 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 on your IHT bill before you can go through the probate process.
You'll need to get a payment reference number from HMRC to pay. You can find more information about it on the Government's website.
Do you have to pay it all at once?
You do not have to pay the whole IHT at once. Instalments are available for:
- Shares and securities, including unlisted shares and securities
- Businesses run for profit
- Agricultural land and property
You have to pay the first instalment within six months of death. Later payments are then due every year on the date you made the first payment. After that, you can pay in annual instalments over ten years, but HMRC will charge interest on these payments. The late repayment rate is 3.25% at the time of writing.
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, savings accounts or British government stock (GILTS). You need to ask the banks, building societies, or National Savings & Investment account to pay through the Direct Payment Scheme.
To do this, you need to ask the bank to make you a personal representative. Each bank will have different requirements and procedures, so contact the bank for more information. You also need to fill out 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. However, if you have a life insurance policy written into a trust, your estate can use this money to foot the bill without having a grant of 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 can't use the money to make the payments, you have to pay IHT from your bank account. You can then claim the money back from the deceased’s 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 you have probate, you can pay back any IHT payments before dividing the rest of the assets. If you've overpaid HMRC, you need to write to HMRC to get a tax return.
When do you pay inheritance tax?
You pay IHT if the estate's value is above the current £325,000 threshold. However, you can increase this threshold to £500,000 if you leave your property to direct descendants. At the same time, your spouse or civil partner can potentially use your unused threshold to lift theirs as high as £1 million.
The main things to remember about IHT deadlines are:
- Your first payment must be within six months
- You should pay the IHT bill from the deceased person’s estate
- If you’re unable to, you need to make the payments using your own money
- You can claim the money back from the estate later
The payment process is simple enough, but it is a good idea to understand if you need to pay IHT. Inheritance tax works differently from one family to another. Knowing about it can help family members cope with making the payout and even reduce the IHT bill. In addition, chatting with a financial adviser can help with estate planning and prepare for possible payments in advance.