How to Calculate Inheritance Tax

Calculating inheritance tax

Inheritance tax (also known as IHT) is tax charged on the value of the estate of somebody that has passed away. This is usually charged at a rate of 40% on anything that exceeds the £325,000 threshold.

The financial implications of losing a loved one can seem very intricate and detailed. The first steps are to calculate how much inheritance tax you owe (if any).

You also need to be aware of what the rules are regarding paying tax on property, donations, gifts and life insurance among other things.

In this guide, we’ll walk you through how to calculate the tax on an inheritance and the various nuances and caveats that you might want to consider before you begin the payment process.

How much is inheritance tax in the UK in 2022-2023?
What percentage of the inheritance is taxed?
How is inheritance tax calculated?
Can you pay inheritance tax in instalments?
Calculating inheritance tax for couples
Calculating inheritance tax on property
Charity donation exemptions
How much tax do you pay on life insurance inheritance?
How to calculate inheritance tax on gifts
How can Level help you pay your inheritance tax sooner?

How much is inheritance tax in the UK in 2022-2023?

You will only be required to pay inheritance tax if the value of your loved one’s estate is more than £325,000.

As of January 2022, new rules apply regarding some of the administration processes of reporting inheritance tax. The £325,000 threshold (also known as the nil rate band) has not changed, however, since 2009. And the Government has announced that this will be frozen until 2026 at the very least.

it is no longer mandatory to report any IHT if there is no IHT to pay and the estate’s value falls below the £325,000 threshold.

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What percentage of the inheritance is taxed?

In the UK, inheritance tax is calculated at a standard rate of 40%. This only applies to the part of the estate that goes over the threshold, meaning the first £325,000 is tax-free. But let’s say your inherited estate is worth more than that. Below we’ve outlined how much you would have to pay, using some examples.

What if you live in Scotland or Wales?

Though there are some differences with regards to Wills across the three countries, the threshold and percentage of inheritance which is taxed is uniform across England, Scotland and Wales.

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How is inheritance tax calculated?

If you are applying for probate you will need to calculate the value of the deceased person’s estate, including all money, property and possessions. This will help you determine if you need to pay IHT and if so, provide a basis for you to calculate how much.

If the estate is a particularly large one, be prepared for this process to take several months. Bear in mind that you are required to send the forms declaring the value of the estate within one year of the person’s passing. You are also required to start paying the tax by the end of the sixth month after their death.

It is possible to start paying the tax before you have finished valuing the estate and obtained probate. This is done by paying from your own bank account (known as “payment on account”) and then claiming it back from the estate later.

Knowing how inheritance tax is calculated in the UK is the first step. Once you have worked out the value of the estate, you will want to subtract the aspects that are exempt from tax, to see if the amount falls above or below the threshold that determines whether any tax is owed.

Using an inheritance tax calculator

Using a reliable online tool is a great way to get an idea of how to calculate your inheritance tax. The Government website offers a grossing up calculator to help you figure out how much the estate is worth once any exemptions have been applied.

Some of the things the inheritance tax calculator will ask you to input include details such as the value of any assets that are not passed under the Will (e.g. if the property was under shared ownership with a spouse who is still living) and the value of any gifts made to the beneficiary(ies) that are exempt from inheritance tax (gifted over 7 years ago).

If you want to get an idea of how much the estate is worth by adding together the components that are taxable, rather than subtracting the ones that aren’t, Which? also has a useful inheritance tax calculator that you can use as a guide.

When you have done that, there is an inheritance tax calculation form that you will need to fill out and send to HMRC. This is officially referred to as the IHT400 and, as mentioned previously, needs to be sent within one year of the person’s death.

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Can you pay inheritance tax in instalments?

A common situation executors find themselves in is to be financially unable to pay the inheritance tax up front. This is likely to be the case particularly when it comes to estates that are asset-rich and cash-poor. The only ways to pay IHT on a property up front are by using personal funds or with a loan.

If the estate includes property, you may be able to pay in instalments, but you will have to apply to HMRC to be able to do this

If these payments are delayed, HMRC may charge further interest on the amount of IHT that was owed as a penalty.

Interest will be charged as standard on all instalment payments except the first one, and further interest is charged on any payments that are late. The repayment and late payment interest rates often change, so if this is something that affects you, make sure you check which rates apply.

If you are able to pay by instalment, the first instalment will be due at the end of the sixth month after the person died. From then on, your annual instalments will be due on this date.

One important thing to note with this option is that you will be required to pay interest on the outstanding balance. To work out how much that will cost, use the inheritance tax interest calculator on the HMRC website.

If at any stage you wish to stop making instalments and simply pay the rest in one go, you can write to HMRC Trusts and Estates and ask for a final assessment. You would not need to include the payment at this stage.

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Calculating inheritance tax for couples

If you are inheriting the full estate from a spouse or civil partner, any assets that have been left to you (provided you also live in the UK) will be exempt from IHT. This means that a civil partner or spouse can inherit entirely tax-free.

Further to this, as a spouse or civil partner, you also have the benefit of being able to apply their unused nil rate band (the £325,000 that would be tax-free) to your own estate. This would only apply to a situation where the whole estate was left to you, but if the deceased person has left a portion of their estate to anyone else, the value of that would be subtracted from the surviving partner’s tax-free allowance.

For example, if a loved one has left £100,000 to another person, the partner would then be able to add £225,000 to their own estate’s tax-free allowance, rather than the full £325,000.

If you were part of an unmarried couple and you are trying to calculate inheritance tax, whether you need to pay IHT on property will depend on several things. If everything has been left to you in the Will and you were a joint tenant (meaning both of you owned the property), you would still have to pay inheritance tax on any assets that exceed the threshold.

Even if you weren’t included in the Will, the “right of survivorship” principle may apply to your situation, meaning that you could still be able to inherit the property, but would have to abide by the standard IHT rules.

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Calculating inheritance tax on property

When it comes to calculating inheritance tax on property, there is another thing to consider. If property has been left to direct descendants such as children or grandchildren, this has the benefit of an additional tax-free allowance called the “residence nil rate band” (also known as the “main residence band”).

The value of this additional tax-free allowance is £175,000. This means that if you are a direct descendant who has inherited property, inheritance tax may not actually need to be paid unless the value of the estate is £500,000 or above. This is relevant if you are inheriting a property that has been the main residence of the person who has died, such as a house.

If an individual (who has not shared a property with a spouse) leaves a home to a direct descendant, they will qualify for the £175,000 nil rate band on top of the standard £325,000, meaning that the tax-free threshold becomes £500,000. If the last surviving member of a married couple dies and leaves their property to direct descendants, the nil rate band and standard threshold for both people are combined, meaning that the tax-free amount is £1 million.

This allowance won’t apply to you if the property has been left in a discretionary Will or trust, however.

One other small caveat to bear in mind is that the £175,000 allowance only applies on estates worth less than £2 million. When the value exceeds this, the residence nil rate band will decrease by £1 for every £2 above the value of £2 million.

If you are selling a property you have inherited and this is not your primary residence at the time you sell it, you may have to pay capital gains tax as well. This will only apply to you if the value of the property has increased since the person’s passing and you have not made a loss from other costs (e.g. estate agents and solicitors’ fees).

For the purposes of accurately calculating the capital gains tax due on inherited property, ensure you keep all receipts for any major work you have had done on the home to increase its value since your loved one died. Deduct any costs associated with selling the property (such as fees paid to solicitors, estate agents and surveyors) and this will give you an idea of what you need to pay capital gains tax on.

For calculating any tax due on the sale of an inherited property, there is a useful website. You have 60 days from the sale completion to pay your capital gains tax to HMRC.

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Charity donation exemptions

The rules may also be slightly different on estates where a charitable donation has been made. A donation can take the form of a fixed amount of money, a particular item, or whatever remains once other gifts have been passed to beneficiaries.

If a donation to charity has been left in the Will, there are two possibilities. The donation will either be taken off the value of your estate before the inheritance tax is calculated, or, if 10% or more of the net value (the value after any debts have been deducted) of the estate is donated, the IHT rate will be reduced to 36%.

For donations that include any gifts of property, the charity would be excluded from having to pay any capital gains tax.

The Government’s inheritance tax charity exemption calculator can help you figure things out for estates where a donation has been made. This inheritance tax reduced rate calculator is only relevant as long as the death took place after 6 April 2021. Also, the reduced rate generally applies as long as there are no charges from the deferral of tax for woodlands or heritage assets (the tax for these is always 40%) and as long as IHT is not due on a trust.

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How much tax do you pay on life insurance inheritance?

Usually, the pay-out from a life insurance policy will be regarded as part of the estate, and will be liable for inheritance tax if it takes the value of the estate above the threshold. The standard 40% rate applies to this.

If the policy has been put in a trust (i.e. a legal arrangement that appoints trustees to look after the policy holder on their behalf), the pay-out will go directly to the beneficiaries, which is advantageous because that means no inheritance tax will be applied to it.

If the person who died had a “whole of life insurance” policy, this would help you get the inheritance tax paid off very quickly. This type of policy includes a clause that ensures the insurance company will foot the whole IHT bill when the policy holder dies.

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How to calculate inheritance tax on gifts

If you received a gift from your loved one while they were still alive, this may be included in their estate and included in the liability for the inheritance tax that you, the executor, may have to pay. This may impact how you calculate inheritance tax.

This all depends on when the gift was made. If it was more than 7 years in advance of their passing, there is no inheritance tax to pay. If the person passed within that timeframe, the following rates apply to the amount of IHT that will need to be paid:

• Within 3 years of giving the gift – 40%
• Within 3 to 4 years – 32%
• Within 4 to 5 years – 24%
• Within 5 to 6 years – 16%
• Within 6 to 7 years – 8%
• After more than 7 years – 0%

Certain gifts made within 7 years are exempt. These include any that are:

• Made to a spouse or civil partner
• Made to charities
• Made to another person of up to £250
• Made to help an elderly relative or a minor to assist them with their living costs
• Worth less than £3,000 within one tax year
• Gifts made out of income.

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How can Level help you pay your inheritance tax sooner?

If you need help calculating your inheritance tax liability, getting some of your inheritance before probate is obtained, or you’re looking for a loan that can help you pay the IHT, we can offer a variety of helpful options.

Our Executor Loan for inheritance tax is a great solution for executors faced with an unexpected IHT bill. With no credit checks and no monthly repayments, we make it simple for you to pay HMRC what you owe and then simply settle the loan once the remainder of the inheritance has been made available to you.

If you are a beneficiary who would like to access your inheritance sooner, why not fill out our online form and see if you qualify for our Inheritance Advance? If eligible, you could get an advance of up to 60% of the money that you are due to receive from the estate.

So, if you’d like to know more, please don’t hesitate to get in touch by giving us a call on +44 (0) 20 7205 2870 or contact us, and we’ll be more than happy to speak to you.

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UPDATE: Changes from 2024 Autumn budget

A number of changes were announced in the 2024 Autumn Budget will affect Inheritance Tax in the coming year:

• From April 2027, unused pension funds will be included in the value of an estate for inheritance tax purposes, removing the previous exemption.
  
• Starting April 2026, 100% relief for business and agricultural property is capped at £1 million of qualifying assets. Assets exceeding this threshold will receive a reduced relief rate of 50%.
• The main rates for capital gains tax have increased from 10% and 20% to 18% and 24%, respectively, effective from October 30, 2024.