If you are in the process of Estate Planning or writing your Will, then Inheritance Tax (IHT) is likely to be on your mind. Understanding the cost of passing your property, money and possessions is important to help protect your wealth and reduce the financial burden on your loved ones. It’s possible to reduce or even eliminate IHT, but first, you need to understand how much – if any – inheritance tax will be due.
In its simplest form, Inheritance Tax is calculated by subtracting the tax-free allowance of £325,000 from the total value of your estate (i.e., money, property and possessions). The remaining amount is taxed at 40%. Transfers between married couples or civil partners are exempt, and any unused allowances can be transferred to the surviving partner.
Most estates do not incur any IHT at all thanks to the various exemptions and allowances. However, with rising property prices, you may find yourself closer to the limit that you expect.
To understand more about Inheritance Tax rules and how much tax might be due on your estate, read on for our guide on how to calculate IHT.
For personalised advice from our expert team, talk to Redwood Financial. Our financial advisers have helped thousands of people to reduce their Inheritance Tax liability and protect their legacy for their loved ones. Contact us today for a consultation.
What is Inheritance Tax?
Inheritance Tax (IHT) is due on the value of your estate when you die, if it exceeds the tax threshold put in place by HMRC. The vast majority of estates avoid being taxed because of the tax-free allowances and exemptions available – more on this below.
You won’t usually pay IHT if:
- The value of your Estate is below the £325,000 threshold
- You leave everything above the £325,000 threshold to your spouse, civil partner, a charity, or a political party.
The Executor(s) of your will are responsible for valuing your estate and paying Inheritance Tax no later than six months after your death. Only then will the estate be distributed as set out in your will. If your Estate value is below the threshold, the executors must still report it to HMRC through Probate.
Redwood Financial’s guide to calculating inheritance tax liability
Calculating IHT is a logical process, but there is a complicated system of exemptions and reliefs to consider.
To help you estimate how much Inheritance Tax might be due on your Estate, we’ve broken it down into four simple steps, as follows. However, it is essential to get advice from an experienced Estate Planner, especially if your Estate is large. We can help you structure your finances in the most efficient way and help you minimise unnecessary tax, protecting more of your estate for your loved ones.
Step 1: Add up the total estate value
Your “Estate” is everything you own on the date of your death, including your property, savings, and other assets, after any debts and funeral expenses have been deducted.
Crucially, it must be calculated according to its market value, not the price you originally paid.
Here’s a list of what an estate might include, and how to value it:
- Your home and any other property – The current market value at the date of death, usually confirmed by at least one estate agent.
- Savings and cash – The exact balances shown on bank statements.
- Investments, ISAs, shares and bonds – Open-market value on the date of death, based on official statements or share prices.
- Life insurance (if not written in trust) – The full policy payout amount.
- Vehicles, jewellery and personal possessions – The realistic second-hand market value, often using online marketplaces, trade guides or specialist valuations.
- Business interests – The open-market value of the business or shareholding at the date of death, considering assets, profits and market conditions.
- Foreign assets – Valued at their local market value on the date of death and converted into sterling using the current exchange rate.
2. Subtract allowable deductions (minus debts and liabilities)
Once you have calculated the value of your Estate, you then subtract certain debts and liabilities to arrive at its net value.
Allowable deductions include:
- Outstanding mortgages
- Loans and credit agreements
- Funeral expenses
- Unpaid bills
- Certain costs incurred while administering the estate
Step 3: Apply inheritance tax allowances
This is where you can reduce or eliminate your Inheritance Tax liability.
The Nil-Rate Band (NRB)
Everyone in the UK can pass on £325,000 tax-free, known as the Nil-Rate Band. If your estate is worth less than this, there is no inheritance tax to pay.
If you’re married or in a civil partnership, any unused NRB can be transferred to the surviving spouse, which means a couple could pass on up to £650,000 tax-free.
The Residence Nil-Rate Band (RNRB)
If you leave your home to your direct descendants, be that your children, adopted children or grandchildren, the RNRB applies. This adds up to £175,000 extra per individual. Combined with the standard NRB, this raises the tax-free threshold to £500,000 per person or £1 million per couple.
It’s important to note:
- The RNRB only applies when passing a qualifying residence to direct descendants, not to nieces, nephews, Godchildren, siblings or friends.
- For a property to qualify, you must have lived in it at some point in your life.
- For larger estates (over £2 million), the allowance is tapered.
Step 4: Calculate the Inheritance Tax Liability
After applying the available allowances, any remaining value is subject to Inheritance Tax at the standard rate of 40%. The rate may be reduced to 36% if at least 10% of your net estate is left to charity.
What is exempt from Inheritance Tax?
There are a few exemptions and reliefs that can significantly lower IHT liability, as follows:
Lifetime gifts
Giving gifts during your lifetime, such as money, property or valuables, can be an effective way to reduce the value of your estate and the tax due on it, but there are important rules to follow.
You can give up to £3,000 each tax year using your annual exemption, and any unused allowance can be carried forward for one tax year. There’s also no limit on gifts between spouses or civil partners, or on gifts to charities or qualifying political parties.
Larger gifts, known as “potentially exempt transfers”, can also reduce IHT, but you must survive for seven years after making the gift for it to fall fully outside your estate.
Business and agricultural relief
If a family business or a farm forms part of your estate, it may qualify for Business Property Relief or Agricultural Relief, which can reduce the taxable value of eligible assets by 50% or even 100%. The rules are complex, and not every asset within a business or farm will automatically qualify.
Getting professional advice can help ensure you structure ownership correctly and make the most of the reliefs available.
How financial planning reduces your Inheritance Tax liability
With the right planning, you may be able to reduce your IHT burden significantly or avoid it altogether.
At Redwood Financial, we work closely with our clients to develop long-term plans that protect their assets and ensure that as much of their wealth passes on as possible. Some effective planning strategies include:
- Making use of annual gift allowances
- Setting up Trusts to protect assets for future generations
- Writing life insurance policies in trust so the payout falls outside the estate
- Structuring property ownership to maximise the RNRB
- Taking advantage of business property relief where eligible
- Reviewing your Will regularly, especially if your financial or family circumstances change
Need Inheritance Tax advice? Contact us today
At Redwood Financial, we combine our expertise in both Estate Planning and Financial Planning to tackle your Inheritance Tax liability on both fronts. Bringing the two disciplines together means you will gain a more comprehensive understanding of all the different ways to legitimately mitigate your Inheritance Tax bill and protect your legacy for your loved ones.
Contact us to talk about Inheritance Tax Planning.
Frequently asked questions – how is inheritance tax calculated in the UK?
Does life insurance count toward your estate?
Life insurance can count toward your estate if your policy isn’t written in trust, meaning the payout may increase the inheritance tax bill your loved ones face. By placing the policy in trust, the money is paid directly to your beneficiaries, bypassing your estate entirely. This simple step can protect the full value of the payout and prevent unnecessary tax.
Are Inheritance Tax calculators accurate?
Online Inheritance Tax calculators can provide a helpful estimate, but they don’t factor in reliefs, gifting, trusts or complex family arrangements. A review by a professional estate planner will always provide a clearer and more reliable picture.
