If you own very many assets – often the most valuable of which might be your own home – it is useful to understand what inheritance tax (IHT) is and whether it will affect you if you make a gift now or whether any tax will be due on your estate when you die. This short guide gives an overview only, so you might need to take further advice.
IHT is charged on gifts and other transfers of cash or assets that you make. Assets are things you own such as your house, shares or other possessions.
There are some gifts that are free from IHT and we will also look at them here.
For more information on IHT have a look at the comprehensive section on the HMRC website.
The topics covered in inheritance tax include:
What gifts are free from IHT?
Lifetime tax free gifts
Gifts that are tax free during your lifetime and on death
What rate of tax will I pay on my gifts?
Will I have to pay tax straight away if I make a gift during my lifetime?
How do I work out the tax due on a lifetime gift?
How do I work out the tax if someone dies?
Retaining a benefit in something you give away
Transfer of the nil rate band
Some gifts are completely free from IHT whether made in your lifetime or on death, and others are tax free if you make them during your lifetime (as described below).
If any gift is free of IHT on death it will not be included in your estate when working out whether any tax is due. When you die, your estate is the total of your assets valued at the date of death less certain expenses such as funeral expenses.
Important note: A gift free of IHT is not necessarily a gift free of capital gains tax (CGT).
- You can make gifts under more than one of the following headings in each tax year.
Back to the top
Small gifts to the same person
You can make outright gifts of up to £250 to any one person in a tax year.
The total gifts to any particular individual must not be more than £250 in that year.
You cannot combine this exemption with any other exemption for lifetime gifts, such as a gift on marriage.
Annual Gifts of up to £3,000
You can make gifts of up to £3,000 in total in any tax year and these are tax-free. It does not matter how many people you make gifts to but the overall limit is £3,000.
A husband and wife (and civil partners) each have their own £3,000 exemption.
If you have not used your allowance of £3,000 for the previous year you can use that as well, but only after you have used the later year's exemption in full.
Gifts in consideration of marriage or registration of a civil partnership
You can give wedding gifts (or gifts to the registering a civil partnership) free of IHT of the following amounts:
- Up to £5,000 to each of your children, stepchildren or adopted children or their intended husband or wife (or civil partner)
- Up to £2,500 to each grandchild or their intended husband or wife (or civil partner)
- Up to £1,000 to anyone else
Normal expenditure out of income
Gifts that are part of your pattern of normal expenditure can be IHT-free but you must be able to make the transfer out of your income (after tax) without reducing your standard of living. For example, Christmas presents might fall into this category, or for instance you might decide to put a set amount out of your surplus income into a savings account for a grandchild – say, £50 a month by standing order.
You might need to use some of your capital to help with the maintenance of your husband or wife (or civil partner), ex husband or ex wife, children under 18 or in full time education or a dependant relative. Such transfers are IHT-free.
Jack and Chloe - lifetime gifts and whether taxable
Jack and Chloe have been married for 40 years and have a son, two married daughters and five grandchildren. During 2012/13 they made no gifts at all but during 2013/14 Jack gave each of his grandchildren a gift of £250 each. Chloe gave £5,000 to their son as a wedding present and a further £5,000 to help in setting up his new house. Jack gave his disabled sister £4,000 to help with her nursing home costs. He also gives a £1,000 out of his income every year to his brother.
None of these gifts are taxable:
- Jack's gifts to each of his grandchildren were within the £250 limit and are tax-free.
- Chloe's wedding present to her son is also tax-free.
- Chloe has also used up her 2013/14 annual allowance of £3,000, together with £2,000 which she did not use during 2012/123 in making the extra gift to her son of £5,000.
- Jack's gift to his sister is exempt as family maintenance
- Jack's gift to his brother is normal expenditure out of income. Alternatively it could use up £1,000 of his 2013/14 £3,000 annual allowance.
Back to the top
Gifts to your husband or wife (or civil partner)
These are IHT-free for a UK domiciled husband and wife or civil partners. In this context UK domiciled normally means that the wife or civil partner was born in the UK and is a citizen here - check with HMRC if you have any problem with this and there is more information on domicile in our migrants section.
If a wife or civil partner is not UK domiciled the limit for exempt gifts between husband and wife (or civil partners) is different. Up to 5 April 2013, there was a limit on the amount which could be transferred IHT-free to a non-domiciled spouse of £55,000. From 6 April 2013, this limit is increased to £325,000.
Gifts to most UK charities
You can make IHT-free gifts to most UK charities or to registered community amateur sports clubs whether outright or in the form of a trust.
Gifts to political parties
You can make an IHT-free gift to a political party as long as it has at least 2 MPs in the House of Commons or 1 MP and at least 150,000 votes in the last general election.
Back to the top
If gifts you have made have not been free of IHT due to any exemptions, then a potential charge to IHT arises as below. As you will see the starting rate is at 0% so, in effect, you have a further exemption from tax.
For 2013/14, the rate of tax on gifts made during your life is:
- First £325,000 at 0%
- Over £325,000 at 20%
The rate of tax on death is:
- First £325,000 at 0%
- Over £325,000 at 40%
The rate will remain unchanged up to 2014/15.
Back to the top
You do not need to take account of any gifts you make that are tax-free. Check here for lifetime tax free gifts.
Most other non tax-free gifts you make apart from gifts to certain kinds of trust will be what we call Potentially Exempt Transfers or PETs.
This type of gift will become tax free if you live for 7 years after the date you made it. If you die within 7 years the gift becomes chargeable to tax.
You do not need to notify HMRC about any PET when you make it and there will be no tax to pay at the time you make the gift. Over the years you need to keep a record in date order of all the PETs that you make, until the 7th anniversary of each gift when you should take them out of your list.
For IHT there is a tax threshold revised in the Budget each year (for 2013/14 it is £325,000) and below this amount you pay no tax as the rate of tax is set at 0%. It is called the nil rate band. Have a look here for how a nil rate band can be transferred to your spouse or civil partner.
If you die within 7 years of having made a gift and your total transfers to date that are still taxable are less than £325,000 there will be no more tax to pay on any PET that has not reached its 7th anniversary. This is because although the gift is taxable, it is only taxed at 0%. However the PET is still added to your estate and so it does affect the amount of tax paid on death.
If you die within 7 years of making the gift, and all your transfers to date which are still potentially exempt (because they have not reached the 7th anniversary) are more than £325,000, your executors will have some IHT to pay. They can, however, use any annual exemptions or other exemptions that are tax free during your lifetime and on death against each gift first, based on what you had available at the date of the original gift
You look at the earliest gift first and then add on any later gifts in time order so that only the latest gifts that are over the £325,000 limit are taxed. You can see this in the example of Molly below.
Any tax that is then due can be reduced if the taxable gift was made more than 3 years before the date of death by a relief called Taper relief.
The longer the time since the gift was made the less tax you pay. The relief reduces the tax due by 20% per year from 80% in the period of 3-4 years before the death to 20% when the gift was made between 6 and 7 years before the death.
Example - Molly
Molly made no gifts until 5 April 2003 and then she gave away the following to her family. Each of the gifts was a PET at the time it was made:
To Kath, Molly's daughter - a picture (valued at £10,000) on 5 April 2003
To John, Molly's nephew - cash of £10,000 on 5 April 2007
To Jenny, Molly's granddaughter - an antique clock (valued at £6,000) on 5 April 2008
To David, Molly's husband some land (valued at £150,000) on 5 April 2009
To Brian, Molly's brother - some BT shares (valued at £70,000) on 5 April 2011
Molly died on 6 April 2012. Her total estate excluding the above gifts came to £82,500
The gift on 5 April 2002 is not taken into account as it was made more than 7 years before Molly died.
The gift to husband David is tax-free.
The gifts to John and Jenny of £16,000 are now taxable but are below the nil rate threshold of £325,000.
The amount of the threshold remaining is £309,000 (£325,000 less £16,000).
This will be set against the gift to Brian. You can see the tax worked out in the next example.
Brian's gift will not be eligible for any taper relief as it has not passed its 3rd anniversary. However it will be possible to take off the annual exemption of £3,000 for the year to 5 April 2011 and £3,000 for the previous year to 5 April 2010 as these have not been used. This leaves only £64,000 of the gift taxable.
If Brian's gift had been made 5 and a ½ years before Molly's death - taper relief would have reduced the tax by 60% leaving only £25,600 taxable.
Although the gifts to John and Jenny were made over three years ago, because no tax is due on them, no taper relief is given.
Back to the top
If the value of your estate and any gifts made within 7 years is more than the nil rate threshold, any additional tax will be at 40%.
If you have not made any gifts, your executors will not pay any tax if your estate is valued at less than £325,000.
Any IHT payable will be due 6 months after the end of the month in which death occurred.
Example continued from above of Molly working out the IHT due on death
|Looking at Molly's estate: |
| || ||£|
|Gift to Brian (gift of £70,000 less £6000 tax free) || ||64,000|
|Molly's estate || ||82,500|
| || ||£ 146,500|
£146,500 @ 0% (£325,000 less gifts to John and Jenny of £16,000 leaves £309,000 available)
Molly had an unused nil rate band of £309,000. Of this £146,500 has been used against her estate and Brian's gift leaving £162,500 unused. This is available to transfer to David. Have a look at the section on nil rate band transfers and the example on how tax is worked out when David dies.
Let's say however instead of being £82,500, that Molly's estate had been £245,000. In that case then adding on Brian's gift of £64,000 and the gifts to John and Jenny of £16,000 gives a total chargeable to IHT of £325,000 which is the full nil rate band. Therefore in this case nothing would be available to carry forward to be used on David's death.
Taking another example - if Molly's estate had been £263,000 she would have exceeded her nil rate band by £18,000 (263,000+64000+16000-325,000) and this would then be charged to IHT @ 40% so Molly's executors would have tax to pay of £7,200 and again there would be no nil rate band left to carry forward to when David dies.
Back to the top
If you give something away but then continue to enjoy a benefit in the asset or use it, you will be treated for IHT as if you had not made the gift in the first place. A good example of this is when you give away your house to your children - they live elsewhere because they have their own homes and you continue to occupy your home after you have given it away.
The gift will only become a potentially exempt transfer or PET (as described above) when you stop having a benefit in it, so if you should die before this happens the full value of the gift will become part of your estate.
With regard to the gift of your home, there are certain exceptions to this rule if there is an unforeseen change in your circumstances in that you become infirm and are unable to maintain yourself through either old age or illness etc. In addition your occupation of the house must be only what might be expected as provision for your care and maintenance by the donee (person you have given the property to). Bear in mind for this to apply the donee must be a relative.
Example continued - Molly reserving a benefit
Looking at Molly again - if the gift to John in 2007 had been a gift of Molly's own home instead of cash and she continued to live there until she died, she will be treated for IHT as if she did not make the gift to John and therefore Molly's estate will become £82,500 plus the value of her home at the date of her death.
If we take the same example but Molly moved out of the house on 6 April 2010, the gift would become a PET on that date.
Back to the top
People used to have to use their own nil rate band and could not transfer it to a spouse or civil partner. This resulted in convoluted planning arrangements where people had to switch assets between them or own things in joint names as tenants in common to make sure they each used their nil rate band.
But for deaths on or after 9 October 2007 it is possible for the first spouse or civil partner to die to transfer their unused inheritance tax nil rate band.
This means that any part of the nil rate band that was not used when the first spouse or civil partner died can be transferred to the surviving spouse or civil partner for use on their later death.
Where a claim to transfer unused nil-rate band is accepted by HMRC, the nil-rate band that is available when the surviving spouse or civil partner dies will be increased by the proportion of the nil-rate band unused on the first death.
For example, if on the first death the estate of the spouse who has died is £162,500 and the nil-rate band is £325,000, 50% or half of the nil-rate band would be unused.
If the nil-rate band when the survivor dies is £350,000, then that would be increased by 50% to £525,000.
Dealing with the estate on the death of the first spouse or civil partner
The transfer of unused nil rate band applies only on the death of the second spouse or civil partner, so there is no need to agree the amount transferable on the first death with HMRC.
However, you will need to keep full details of the estate of the first spouse or civil partner in a safe place so that the information will be available on the death of the second spouse or civil partner. The information and documents you will need to keep are:
- a copy of the IHT400, IHT205 (C5 in Scotland) or full written details of the assets in the estate and their values
- death certificate
- marriage or civil partnership certificate for the couple
- copy of the grant of representation (Confirmation in Scotland)
- copy of the Will, if there was one
- a note of how the estate passed if there was no Will
- a copy of any Deed of Variation or other similar document if one was executed to change the people who inherited the estate
- any valuation(s) of assets that pass under Will or intestacy other than to the surviving spouse or civil partner
- the value of any other assets that also passed on the death of the first spouse or civil partner, for example jointly owned assets, assets held in trust and gifts made in the 7 years prior to death
- any evidence to support the availability of relief (such as agricultural or business relief) where the relievable assets pass to someone other than to the surviving spouse or civil partner.
As the surviving spouse or civil partner, you may want to keep these documents with your own Will, if you have made one, or with other important documents, to ensure that a claim can be made for the transfer of unused nil rate band on your death.
Dealing with the estate on the death of the second spouse or civil partner
If the estate of the second spouse or civil partner to die is below the IHT nil rate band that applies when they die, there is no need to claim a transfer of the unused nil rate band.
If you need to transfer the unused part of the nil rate band of the first spouse or civil partner to die, because the second estate is above the nil rate band that applies on their death, the executor will need to fill in form IHT400. The form is also available from the HMRC Helpline.
How do I claim the transfer of the unused nil rate band?
The executor or you will need to fill in a claim form IHT402 which you can get from the HMRC Helpline. You should then send in the form to HMRC together with the copy documents requested and form IHT400 for the estate of the second spouse or civil partner to die.
The ability to transfer the nil band between spouses and civil partners for deaths on or after 9 October 2007 does not change the effect of Wills written before then. But it is worth keeping your Will up to date. Small changes need not be made by completely rewriting your Will if what is called a 'Codicil' will suffice.
First death before 18 March 1986
Inheritance tax was introduced with effect from 18 March 1986, but before this date other estate taxes (capital transfer tax and estate duty) applied. Where a surviving spouse dies on or after 9 October 2007 and their spouse died before the introduction of the current inheritance tax provisions, it may be possible to make a claim.
The extent of the claim will depend on the tax in force at the time of the first death and how the rules were applied then. If you need more advice you can contact HMRC's Probate and inheritance tax helpline.
Low value or excepted estates
There are special rules for 'excepted estates' (estates on which no IHT is payable). If the surviving spouse or civil partner's estate exceeds the single nil rate band at their death, the estate cannot qualify as an excepted estate even though there may be no tax to pay because of transferred nil rate band.
The surviving spouse or civil partner's personal representatives must complete a form IHT400 and make a claim to transfer the unused nil rate band.
If the estates of both spouses or civil partners do not exceed one nil rate band, the executors should still work out how much of the nil rate band is available for transfer as the circumstances of the second spouse or civil partner may change before they die.
But if, when they die, their estate remains below a single nil rate band and provided they have not remarried or entered into a new civil partnership, there is no need for their personal representatives to make a claim to transfer unused nil rate band.
Jointly owned assets
If all of the first spouse's assets were jointly owned and so pass automatically to the surviving spouse or civil partner on the first death then provided there were no other assets chargeable to IHT on the first spouse or civil partner's death, the whole of the nil rate band is unused and can be transferred to the surviving spouse or civil partner's estate.
The personal representatives can make a claim to transfer the unused nil rate band. Any other assets chargeable on death, such as gifts made within 7 years of the death, will start to use up the nil rate band.
It will be very important for the surviving spouse or civil partner to keep information about any assets (that they know about) that pass to others, because the value of those assets will affect the proportion of nil rate band that their personal representatives will be able to claim.
The same applies to any other assets that are chargeable to IHT on the first spouse or civil partner's death such as gifts made within 7 years that are not covered any exemptions.
Divorce or remarriage – effect on transfer of nil rate band
If the first spouse or civil partner died during the marriage or civil partnership, and:
- the surviving spouse or civil partner subsequently remarried (or formed a new partnership) but is now divorced - the personal representatives can make a claim to transfer any unused nil rate band from the first husband/civil partner's estate to the remaining spouse or civil partner's estate if a claim is made by the personal representatives.
- the surviving spouse or civil partner remarries or enters into another civil partnership and they die before their new spouse or civil partner - the nil rate band available to the surviving spouse or civil partner will be increased by any unused amount of the deceased spouse or civil partner's nil rate band and this is claimable by the personal representatives.
- the surviving spouse or civil partner dies leaving all their assets to their new spouse or civil partner, then again, the full amount of the nil rate band on their death is available for transfer to their new spouse or civil partner.
The maximum that can be added to anyone's own nil rate band is 100% of the nil rate band for the tax year in which they die.
If an ex-spouse or civil partner has died without remarrying, the personal representatives cannot claim to transfer the unused nil rate band to ex-spouse or civil partner's estate as the marriage must still be in force at the date of death.
Back to the top