How does UK inheritance tax work?

Everybody has an allowance that is free of inheritance tax (IHT) on their death.

Currently (tax year 2018/2019) that allowance is GBP325,000. It has been stuck at this level for a number of years.

Anything above this allowance is taxed at a rate of 40 per cent.

Things subject to IHT

  • Cash
  • ISAs
  • Most investments
  • Property
  • Vehicles
  • Life insurance payouts (where the policy is not written in trust).

Things not subject to IHT

  • Pensions
  • Certain qualifying investments

What happens if assets are passed to a spouse on death?

As long as the spouse has UK domicile, then all assets can be passed to them without an IHT liability.

If the spouse is not UK domiciled (e.g. Polish), then different rules would apply. Read more here.

What happens if a full allowance is not used?

The non used part of an allowance can be transferred to a spouse (as long as the spouse has UK domicile).

For example,  on death, Bob has an estate worth GBP800,000. He passes this to his wife, Fiona. As Fiona has UK domicile, there is no IHT to pay and therefore none of Bob’s allowance is used.

Fiona will then inherit 100 percent of Bob’s GBP325,000 allowance, meaning that she now has an allowance of GBP650,000.

What about a main residence?

The government is in the process of phasing in a Residence Nil Rate Band (RNRB).

This will apply to a family home (or proceeds from the sale if a family home) going to direct descendants only.

In the 2018-19 tax year this is worth an additional £125,000. It will increase to £150,000 in 2019-20 and £175,000 in 2020-21.

Ultimately, this means that married couples will be able to use their combined allowances to pass estates worth up to GBP1 million onto their direct descendants.


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