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What is inheritance tax?

Inheritance tax (IHT) is a tax that will be applied to your estate when you die, if it’s valued over a certain amount.

Your estate includes things like your money, property, investments and belongings. 

Depending on the arrangements you make, inheritance tax could take a sizeable chunk out of your estate, leaving less for your loved ones. But it’s possible to reduce the amount owed – and even pay no inheritance tax at all in some cases.  

What is the inheritance tax-free threshold?

The good news is you may not need to pay inheritance tax if:

  • the value of your estate is below the inheritance tax-free threshold of £325,000

  • you leave everything above the £325,000 tax-free threshold to your spouse, civil partner, a community sports club or charity

If you leave your home to your children (including adopted, foster or step-children) or your grandchildren – your tax-free threshold could go up to £500,000.

If your estate is worth less than the tax-free threshold (£325,000) and you’re married or in a civil partnership – any unused allowance on your death can potentially be added to your partner’s tax-free allowance to use on their death.

Keep in mind – the value of any benefits described will depend on your individual circumstances and tax rules could change in the future.

How much is inheritance tax?

If the total value of your estate is more than your tax-free threshold, then the amount that sits above the threshold will usually be liable for tax at a rate of 40%.

For example, let’s say your estate is worth £550,000 and you want to leave it all to your children. If your tax-free threshold is £325,000, there will be an IHT bill of £90,000 – that’s 40% of £225,000.

To work out the value of your estate:

  • list all your assets including money in the bank, property, possessions, investments, savings and life insurance

  • deduct any debts and liabilities, such as your mortgage

  • calculate, and keep a record of, the current value of your estate, including any property valuations

4 ways to manage your inheritance tax bill

Reducing your inheritance tax isn’t as simple as just giving your estate away before you die. Any money gifted usually counts as part of your estate and may be taxed – if you die within 7 years of making the gift. Therefore, it’s important to plan how you want to pass on your wealth early. 

If you think you may have to pay inheritance tax, here are some ways you can reduce it:

1. Leave money to charity

Normally no tax is due on charitable donations. If you leave at least 10% or more of your net estate to charity, you could reduce the rate of inheritance tax from 40% to 36%.

2. Give away up to £3,000 a year in gifts

The first £3,000 given away each tax year is not subject to inheritance tax when you die. If you don't give away £3,000 in one year, you can carry that allowance forward and give away £6,000 in the next tax year.

3. Make regular gifts out of excess income

Inheritance tax applies to your assets. However, if you regularly give money from your income, such as your pension or earnings, it’s not included – as long as it leaves you enough income to maintain your lifestyle.

4. Hold onto money in your pension

Most pensions don’t count as part of your estate for inheritance tax purposes. 

If you’ve got a defined contribution pension, you can nominate anyone – your spouse, children, grandchildren or even friends – to inherit your remaining fund. 

That way, the money could go to your loved ones without having to pay inheritance tax. Although they may pay income tax depending upon how old you are when you die.

Get help and support with inheritance tax

Estate and tax planning is complicated and much will depend on your individual circumstances. It can be worth getting advice to help you make the right decisions for your situation.

If you have over £100,000 in savings and investments, and hold an HSBC current or savings account, we can offer you a wide range of financial advice – from protecting your family to passing on your wealth. Please note, fees apply.

If you prefer, you can find a specialist estate and tax planning adviser in your area through the MoneyHelper’s Retirement Adviser Directory.

Planning for what you want to happen after you die is an important task that could save your loved ones thousands of pounds. If you haven’t done so already, it’s important to make a will so your wishes are known. It could make the world of difference to your family’s future and even future generations.