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How Does Inheritance Tax Work?

Nigel Merchant, Regional Probate Consultant here at Kings Court Trust, is frequently asked about Inheritance Tax. Here’s what he has to say:

Over the last five years I’ve visited hundreds of bereaved families to discuss, and quote a fixed price for, the administration of their deceased loved one’s estate. One of the points that comes up time and time again is the question of Inheritance Tax. More or less every family I speak to is concerned that Inheritance Tax might be payable but aren’t clear on how it works. Once they realise that if the tax has to be paid, it simply has to be paid, they want to know where it comes from. The answer is that, if there’s any Tax to pay, it will be the estate that pays it.

Many people don’t realise that although Inheritance Tax can be an issue, every estate has a tax free sum (known as the Nil-Rate Band) of £325,000. What this means in practical terms is that if the estate, after all the debts, mortgages, any other liabilities and bequests to charity and/or spouse are taken into account is worth £325,000 or less, there will be no Inheritance Tax to pay. If, after taking these deductions into account, the estate is worth more than £325,000, then Inheritance Tax is payable at 40% of everything over the tax free sum. So if the estate, after all the deductions mentioned above, was worth £330,000, then tax would be payable at 40% of the difference between the tax free sum of £325,000 and £330,000, which is 40% of £5,000, i.e. £2,000.

Many people don’t realise that it’s possible to use their pre-deceased spouse’s tax free sum, if they didn’t use it all themselves. What this means is that if, say, Dad dies with an estate after deductions of £225,000 and leaves it all to his children, when Mum dies her estate will have its own tax free sum (£325,000) AND an extra £100,000 left over from Dad’s estate (assuming Dad’s tax free sum was £325,000 when he died), giving a total tax free sum after all deductions of £425,000. Similarly, if Dad leaves his entire estate to Mum (there is no Inheritance Tax payable between married couples), her estate will have both tax free sums, a total of £650,000.

If Dad had left the £225,000 to the children, there would be £100,000 of his tax free sum left over, as we saw in the example above. However, if the family and everyone else concerned agreed, it would be possible to vary the terms of Dad’s will (within 2 years of his death) to leave more of his estate to Mum so that, when she died, her estate would benefit from a higher tax free sum. Kings Court Trust is very accustomed to preparing the necessary paperwork to make this easy.

Note: All references to spouse and married couples includes registered civil partners

Nigel Merchant is a Regional Probate Consultant at Kings Court Trust and can be reached on nigel.merchant@kctrust.co.uk.