The comprehensive guide to inheritance tax | moneyfacts.co.uk

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Published: 11/03/2021

At a glance

  • Anything received as an inheritance could be subject to inheritance tax of up to 40%, depending on the value of the estate.
  • Make sure you know the rules around tax and any benefits you’re receiving.
  • It’s advisable to consult a professional adviser to get help with managing your inheritance.

What is the inheritance tax 2021?

Under current rules, heirs could be subject to a tax bill of up to 40% on an estate, which includes any savings, property and any additional assets, after deducting any debts and funeral costs. However, inheritance tax (IHT) can be legally reduced or avoided in a number of ways (such as via gifting), and will only be paid on estates worth above a certain amount.

The tax-free IHT allowance for 2021/22 – known as the nil rate band – stands at £325,000. This means only the value of an estate above this level will be taxed at 40%, and if it’s worth less than this, there’ll be no tax for beneficiaries to pay. This tax-free allowance is increased if the estate includes property that is being passed on to a direct descendant, with the transferrable allowance currently standing at £175,000, effectively bringing the nil rate band to £500,000 for many families.

Married couples and civil partners can pass on their allowance to their spouse, too. This means that, provided the first spouse to die didn’t gift a large amount away beforehand, couples can pass on up to £650,000 to beneficiaries tax-free. This rises to £1m if the estate includes property, as per the property transfer allowance.

It’s worth pointing out that heirs rarely pay for IHT directly; it’s usually discounted from the value of the estate and is taken care of by the executors (unless the estate can’t or won’t cover the full amount, in which case the beneficiaries are liable).

How much can you inherit before paying inheritance tax?

As per the rules above, you can potentially inherit up to £1m before paying inheritance tax – if you’re inheriting your parents’ estate, for example – depending on your family circumstances. There are exceptions, however, most notably if you received any inheritance money as gifts in the seven years before the deceased passed away, in which case you’ll have to pay tax on it (though only if the deceased breached their nil rate band), or if you generate an income from the money received, in which case usual income tax rules apply.

The rules can be complex and often depend on your relationship with the deceased. As such, you may want to consult a professional adviser so you know exactly what your tax liabilities are, and how you can potentially mitigate them if necessary.

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How much tax do you pay when you sell an inherited house?

When you receive a house as an inheritance, you may be liable to pay inheritance tax on it depending on the value of the estate – but when you come to sell it, the rules, and potential tax liabilities, change again.

If you’ve kept your current home as your main residence and are selling the inherited house, it counts as a second property, and therefore capital gains tax will be payable on any profit. It’s only the “gains” that are taxed and you’ve also got a £12,300 capital gains tax-free allowance, and any costs involved in selling the property are discounted as well. So, let’s say the property was valued at £250,000 at the time you inherited it, but it’s increased in value to £300,000 when you come to sell it, and you pay £5,000 in costs. You’ll therefore pay capital gains tax on £32,700 (the £50,000 profit minus the £5,000 costs and £12,300 tax-free allowance).

The actual amount of tax you’ll pay will vary depending on your tax bracket – if you’re a higher or additional rate taxpayer, capital gains tax is charged at 28% on residential properties, while for basic rate taxpayers, the rate paid depends on your income and the size of the gain (18% if your taxable gains plus taxable income falls within the basic income tax band, and 28% on any amount above it).

What is the average inheritance?

The average (median) inheritance received is around £11,000, according to the most recent figures from the Office for National Statistics (ONS), but this may be well below the windfall likely to be received by future beneficiaries. Indeed, a report from the Institute for Fiscal Studies found that, thanks to rising wealth and fewer siblings, the median inheritance for those born in the 1960s is expected to be £66,000, rising to £107,000 for those born in the 1970s and £136,000 for those born in the 1980s.

Do you need to declare inheritance money?

Yes. You’ll need to notify HMRC that you’ve received inheritance money, even if no tax is due. If it is, you’ll be expected to pay the tax within six months of the death of your loved one. This will normally be taken out of the deceased’s estate, and the executor will usually take care of it. You’ll also need to notify the Department for Work and Pensions (DWP) if you’re in receipt of any benefits.

What happens when you inherit money?

When you inherit money, you’ll first of all need to make sure that the necessary debts, funeral expenses and IHT have been paid out of the estate, and you’ll need to declare your inheritance to HMRC.

You won’t inherit the money as soon as the person dies, however; there’s a process known as probate to go through, which can take up to a year or longer if things are particularly complex. Typically speaking, you can expect to wait at least six months, even in straightforward cases.

Once you’ve received the money you’re free to spend it as you see fit, though it’s a good idea to consult a financial adviser, particularly if you receive a significant sum, to ensure you’re able to make the most of it and that you’re mitigating any tax liabilities that may become apparent.

What is the best thing to do with inheritance money?

This can be a very personal decision, but there are a few things you may want to focus on.

The first of these things is debt. Using inheritance money to clear any personal debt you may have can be a very wise move, such as paying off maxed-out credit cards or even mortgage balances (see below). It may not be the most exciting of ways to spend an inheritance, but knowing you don’t have any lingering debt to worry about can be invaluable.

You might like to consider who else could benefit from your new-found windfall, too, particularly if you’ve got a very large sum. Many people like to help younger family members onto the housing ladder, for example, or gift some to charity; this may also require professional input so you’re not breaching any gifting rules or tax brackets, so again, it’s always worth speaking to an adviser.

After your other potential obligations are taken care of, it all comes down to making your money work as hard as possible, but deciding how to do that – and where to put it – isn’t always easy.

Where should I put my inheritance money?

This largely depends on your circumstances and what you intend to do with the money, but at the outset, it’s a good idea to keep the sum in an accessible savings account while you decide what to do next. Easy access savings accounts should therefore be your first port of call, but keep a lookout for access and investment restrictions, as some only allow a certain number of withdrawals and others have relatively low maximum investment limits, which may not be suitable for those with a large windfall.

Once you’ve decided what to do with the money, you can look to move it elsewhere. If you want to keep it in cash but at a higher rate you may want to consider fixed rate bonds or ISAs, or if you’ve got a higher risk appetite, stocks & shares ISAs – or similar investments – may be worth considering. This always assumes you’re not using the money elsewhere, such as to purchase property, which could be another way to make it work harder.

Wherever you put your inheritance, make sure to bear in mind depositor protection rules, which are temporarily enhanced in the six months following a major life event (such as receiving an inheritance) and means up to £1m will be protected under the Financial Services Compensation Scheme (FSCS). Just remember to divide the money between different accounts once the six months have expired to make sure you’re suitably covered.

Should I use an inheritance to pay off my mortgage?

It’s always sensible to use inheritance money to pay off any debts, and the mortgage could be top of the list of priorities. Just make sure to account for any exit fees, and if you’re on a fixed rate deal, remember that you may not be able to pay off the full balance without additional charges being applied, so always ensure it’ll be financially worthwhile (it may be worth waiting until the fixed rate period has come to an end before paying it off, but always seek suitable advice to decide on the best course of action).

However, if you’re on a variable rate it should be far easier to pay off the balance; make sure to speak to your mortgage provider to see how you can go about it. If you only receive enough inheritance to repay part of the mortgage, the same rules apply; check how much you can repay each year if you’re on a fixed rate, and speak to your provider if you’re on a variable rate deal. Paying down some of the mortgage may give you the opportunity to remortgage to a lower rate as you’ll be on a lower loan-to-value, so can be a great use of inheritance money.

Will I lose my benefits if I inherit money?

Potentially, depending on the benefits you’re currently in receipt of and the amount of inheritance coming your way. If you’re receiving means-tested benefits (such as income-based jobseeker’s allowance, income support or universal credit), any income and savings you have will affect the amount you’re entitled to – if you suddenly get a windfall in the form of inheritance, this will count as savings, and your entitlements will change accordingly.

Once your savings hit the £6,000 threshold, your benefits will be impacted (the exception to this is pension credit, where you can have up to £10,000 in savings before your entitlement is affected). This means that, if you inherit more than this amount, it’s worth spending time thinking about what you’re going to do with it. Seeking advice is key; Citizens Advice could be a great place to start.

However, benefits that aren’t means-tested (such as the disability living allowance) won’t be affected by receiving an inheritance.

How do you prove inheritance money?

You may need to prove where the large sum of money in your bank account came from – such as if you’re using it to purchase a property, in which case the solicitor will require proof of funds for conveyancing to proceed – but this shouldn’t be too onerous a task. To prove inheritance money you’ll need a copy of the letter from the executors of the estate that sets out how much you’re receiving as a beneficiary, together with your bank statement that shows the funds came from the executor’s/solicitor’s bank account. Keep all relevant paperwork, too.

 

Can creditors come after my inheritance?

If you’re in serious debt and are going through the debt management process, there’s the chance you’ll have to use your inheritance to settle your creditors’ demands, particularly if you’re already in some form of insolvency (such as an IVA or bankruptcy). However, this is an incredibly complex area and seeking advice is crucial; Citizens Advice could be a good place to start. A way to avoid this is if the deceased left the inheritance in a trust, in which case the assets will be shielded from creditors, but this would need to have been arranged before the event.

How do you prove inheritance theft?

If you suspect that someone’s stolen from the estate – perhaps a sibling or family friend wanting to receive inheritance they’re not entitled to, or an executor who steals or embezzles during the administration process – you need to prove that inheritance theft has taken place. This can be a tricky undertaking, particularly if wills are out of date, lost or contested, so it’s worth seeking legal advice.

Is inheritance money protected in divorce?

This depends on your situation, but usually, inherited money will be counted as “non-matrimonial assets” and therefore won’t automatically be included in the calculation of assets to be divided in the divorce. It may be excluded completely if both parties agree, though if the matrimonial assets won’t be sufficient to cover the financial needs of both individuals, then non-matrimonial assets may be included – which is where it could get difficult.

It can often depend on how the money was used; if it went into a joint account and was used to benefit the whole family, for example, it may be viewed as joint property and will be divided accordingly. It can also depend on when the inheritance was received (if it was before the marriage, for example), if there was a pre-nuptial agreement or how long the marriage lasted for. However, such things are always decided upon on a case-by-case basis, so it’s vital to get the necessary legal advice in this situation.

How does an inheritance trust work?

An inheritance trust is a way for someone to more effectively manage their estate, giving them an element of control in how the assets are passed on and used. They’re often used as a way to reduce inheritance tax, though it will still need to be paid and it can still be expensive.

The creator of the trust would have placed certain assets in the trust and will stipulate how it should be run. Trustees will be nominated to manage the trust when the creator passes away – they’ll become legal owners of the trust at that point – and beneficiaries will be nominated in the usual way. Assets held in trust don’t form part of the estate and therefore won’t be taken into account in inheritance tax calculations – provided they were placed in trust more than seven years before the individual died – but tax would still have been paid (see below).

Read more in our guide about how trusts work.

Do beneficiaries pay tax on inheritance from a trust?

If the estate being passed on exceeds the deceased’s IHT allowance, then yes, tax will need to be paid on inheritance from a trust – but the rules are slightly different. The deceased would have already paid 20% inheritance tax on all assets when they were originally put into the trust, as well as a 6% tax charge (less the IHT allowance) on each 10-year anniversary; when the trust is closed or the beneficiaries otherwise remove the assets, another tax charge is applied of up to 6%, depending on when the most recent 10-year valuation took place.

However, these rules can vary depending on the type of trust that was initially set up; it’s important to speak to a professional for advice.

Can I get my inheritance in cash?

This will depend on the assets you’re entitled to receive. If you’re inheriting money then it will usually be paid into your bank account as cash from the estate itself (via the executor’s/solicitor’s bank account). However, if you receive shares or property, there’s nothing to stop you from selling them and taking cash at a later date, though additional tax liabilities may need to be considered.

Can I sign over my inheritance to someone else?

Yes. If you don’t want to keep the inheritance for any reason, you’re free to sign it over to someone else you nominate by drawing up a “deed of variation” no more than two years after the deceased passes away. It’s wise to take legal advice before proceeding to account for any potential legal and tax implications.

Does an inheritance count as income?

An inheritance itself doesn’t automatically count as income, but if you were to receive an income as a result of using the inheritance – such as if you invested the money and earned interest or dividends from it, or earned rental income from a property you bought with the inheritance – the proceeds would count as income and would count towards your income tax calculation.

Does an inheritance affect my pension?

No – unless you want to add the inheritance to your private pension pot, in which case it will impact it in a positive manner – and nor will it affect your entitlement to the state pension, though it may affect pension credit if you’re in receipt of it. It’s worth speaking to an adviser if you’re unsure.

How much money can be passed on before you have to pay taxes on it?

This depends on your relationship to the recipient. The inheritance tax (IHT) nil rate band is £325,000 for the 2021/2022 tax year, so if the value of the estate is worth less than this, there’ll be no inheritance tax to pay. However, couples can pass on their tax-free allowance to each other, who can then pass on the full amount to their direct descendants, meaning if you’re receiving inheritance from a parent, you may not pay tax on anything under £650,000 (this increases to as much as £1m if property is involved; read more about how inheritance tax works).

However, as mentioned, you’re unlikely to have to pay IHT directly as it’s usually covered by the proceeds of the estate. The exception is if you received the money as gifts in the seven years before the deceased passed away, in which case you’ll have to pay tax on it (but again, only if the deceased breached their nil rate band), or if you generate an income from the money received, in which case usual income or capital gains tax rules apply.

 

Will my inheritance affect my benefits?

If you’re in receipt of means-tested benefits, then yes, inheritance money can impact your eligibility. This will depend on the amount of inheritance you receive, but with any savings above £6,000 (or £10,000 in the case of pension credit) being enough to impact your entitlement, it’s likely that your benefit payments will be affected. If you’re concerned, speak to someone such as Citizens Advice for support.

What happens when you inherit money from a trust?

This can depend on the type of trust it is, but typically speaking, it should simply be a case of asking the trustees to pay you the money you’re entitled to. Alternatively, if there are several beneficiaries and everyone agrees, the trust could be wound up and the money distributed according to the will.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

At a glance

  • Anything received as an inheritance could be subject to inheritance tax of up to 40%, depending on the value of the estate.
  • Make sure you know the rules around tax and any benefits you’re receiving.
  • It’s advisable to consult a professional adviser to get help with managing your inheritance.

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