Regardless of whether you live inside or outside of the UK, you likely know about the impact inheritance tax in the UK might have on your future finances. Fortunately, inheritance tax in the UK only affects a proportionally small number of estates, so there’s a good chance you won’t be impacted by it.
However, if you are set to inherit the estate of a close relative who has passed away, and their estate falls into the taxable category, then it can be useful to know how inheritance laws work so you can avoid paying unnecessary fees.
In order to help you wrap your head around this sometimes complicated process, we’ve broken down everything you need to know about UK inheritance taxation to make the process as simple and stress-free as possible.
What Is Inheritance Tax?
In layman’s terms, inheritance taxation is a tax that is levied on the inherited wealth left to you by a specific individual upon their death, according to where they bequeathed their estate and how much has been bequeathed to each beneficiary.
The estate of said individual is a combination of all of their accumulated wealth and assets, and if it reaches a certain allowance threshold, a tax will be levied on it. What falls under an estate can include, but is not limited to, the following:
- Money
- Pensions (from April 6, 2027, unused pension funds and death benefits will also be included in the value of the estate for inheritance tax purposes)
- Shares and investments
- Property
- Land
- Personal possessions
- Insurance pay-outs
- Jointly owned assets
Only after any necessary tax on inheritance has been paid can an estate’s assets be distributed to the requisite beneficiaries. It is vital that this tax is paid as soon as possible to release the estate into your possession and prevent it from being claimed by the government.
Who Pays Inheritance Tax?
Under UK law, the individual who covers the payment of this specific tax will always be the executor of the deceased’s will, or the administrator of their estate if no executor is stated.
As a result, you won’t necessarily pay tax on what you inherit directly from your accounts. Instead, the cost of the tax will be taken from the estate’s overall value after the tax-free threshold.
Why Do You Pay Inheritance Tax In The UK?
The main idea behind the tax is to prevent the accumulation of wealth upon the death of an individual. Instead, some of the wealth is redistributed to the state, ensuring that it can be directed towards projects and services that benefit everyone in the country.
Laws Surrounding UK Inheritance Tax For Non-residents
Even if you’re not a direct resident of the UK, there is a chance that you may have to pay inheritance tax upon the death of a relative. This tax is most commonly applied to UK-situated assets, such as property, land, shares in UK companies, and personal possessions located in the UK.
For example, if you inherit UK property or land, inheritance tax is calculated based on the value of these assets at the time of the owner’s death, regardless of whether you choose to sell them. It’s important to note that non-residents are liable for inheritance tax on any UK assets that exceed the inheritance tax allowance threshold, currently set at £325,000.
Additionally, other estate assets such as money held in UK bank accounts and insurance pay-outs from UK policies may also be subject to inheritance tax if they breach the allowance limit.
While the rules surrounding inheritance tax for non-residents can be complex, understanding how UK-situated assets are treated under these laws is essential to managing your tax obligations effectively. If you have significant UK assets, it’s wise to seek professional advice to ensure you comply with these regulations and take advantage of any available reliefs or exemptions.
Inheritance Tax Laws For UK Expats
Naturally, inheritance tax also affects expats living outside of the UK whose domicile remains inside UK territory. Changing your domicile can mitigate this liability; however, the process is not straightforward and involves more than simply proving that you no longer reside in the UK.
To change your domicile, you must provide substantial evidence of a permanent intention to reside outside the UK and demonstrate that you have severed significant ties with the country. This includes factors such as establishing a permanent home abroad, relocating your family, and ceasing to own property or maintain financial ties in the UK. Even then, the process is subject to scrutiny by HMRC.
It’s also important to be aware of the “deemed domicile” rules. Under current laws, if you were a UK resident for at least 15 of the last 20 tax years, you will be treated as UK-domiciled for inheritance tax purposes, regardless of your actual domicile. This means your worldwide assets remain liable for inheritance tax.
Finally, even after changing domicile, you may still be liable for inheritance tax if you own UK-based assets such as property, land, or shares in UK companies. These assets are always subject to UK inheritance tax, regardless of your domicile status.
Understanding the complexities of domicile and how it affects inheritance tax liability is essential for UK expats. Professional advice can help you navigate these rules and plan your estate effectively to minimise tax exposure.
What Is The Inheritance Tax Threshold In The UK?
As we’ve previously mentioned, although this tax can be levied on an estate, the value of said estate must first pass the inheritance tax allowance in the UK set by the government.
The current allowance threshold is set at £325,000, known as the nil-rate band. This threshold has been frozen and will remain at this level until April 2028. However, this cut-off point can be increased to £500,000 if the individual that died owned, or part-owned, their home, or if they have bequeathed this home to their child, foster child, stepchild, or grandchild. This increase is due to the additional £175,000 allowance provided by the residence nil-rate band.
Unfortunately, once an estate passes the value of the combined inheritance tax allowances, a percentage of payment—typically 40%—will then be levied on any remaining wealth after the threshold.
It’s also important to understand how gifting affects inheritance tax. Every individual in the UK has an annual gift allowance of £3,000 during their lifetime. Gifts exceeding this amount may be subject to inheritance tax if the individual passes away within seven years of making the gift. However, once inheritance tax has been settled on an estate, beneficiaries are generally not required to make further tax payments on their inheritance.
What Are The Different UK Inheritance Tax Rates?
As with many taxes, there are a variety of rates that can be applied to inheritance tax. In the UK, the base rate of this tax is set at 40%, which applies to the value of an estate exceeding the inheritance tax allowance, regardless of the contents of the estate in question.
However, the good news is that this percentage rate can taper off for lifetime gifts made within seven years before the owner of the estate’s death, eventually disappearing entirely after seven years. This reduction is known as taper relief, which applies only to gifts that exceed the available inheritance tax nil-rate band.
Below are the different percentage rates based on the time elapsed between the gift and the donor’s death:
| Period of time between gift and death | Tax rate |
| Less than 3 years | 40% |
| 3 to 4 years | 32% |
| 4 to 5 years | 24% |
| 5 to 6 years | 16% |
| 6 to 7 years | 8% |
| 7 or more years | 0% |
It’s important to note that taper relief reduces the tax payable on the gift, not the value of the gift itself. For example, if a gift made three to four years before death exceeds the nil-rate band, the tax rate on that gift would be reduced to 32%, rather than the full 40%.
What Are The Inheritance Tax Exemptions?
While many people will end up paying this tax in some capacity, there are a few exemptions that can reduce or eliminate this requirement.
First and foremost, if the deceased leaves the entirety of the wealth above the inheritance allowance threshold to their spouse or civil partner, no tax is payable due to the spouse or civil partner exemption.
Additionally, if an individual dies and their estate is worth less than their tax allowance, any unused portion of their nil-rate band can be transferred to their surviving spouse or civil partner. This means the surviving partner’s inheritance tax threshold can effectively double, reaching up to £650,000. When combined with the residence nil-rate band, the maximum possible threshold can increase to £1,000,000 per couple if the family home is bequeathed to a child, foster child, stepchild, or grandchild.
On top of this, no inheritance tax is payable if all wealth above their allowance is bequeathed to a charity or community amateur sports club. Furthermore, if 10% or more of the net value of the estate is left to charity, the inheritance tax rate on the remaining estate can be reduced from 40% to 36%.
As we’ve previously mentioned, it is still possible to pay inheritance tax on certain gifts, depending on the circumstances. Every individual in the UK has what is known as an annual gift allowance, which means that up to £3,000 worth of assets or cash can be given away each tax year without being considered for inheritance tax. Gifts exceeding this allowance are classified as ‘potentially exempt transfers’ and may be subject to inheritance tax if the donor passes away within seven years of making the gift. If the donor survives for more than seven years, the gift becomes fully exempt.
Some types of gifts are exempt from being included in the annual gift allowance, allowing them to be given without incurring inheritance tax liability. These include:
- Small gifts worth £250 or less to an individual who has not already received a gift from your annual gift allowance.
- Wedding or civil partnership gifts:
- Up to £5,000 for a child.
- Up to £2,500 for a grandchild or great-grandchild.
- Up to £1,000 for any other relative or friend.
- Gifts to help with living costs for an ex-spouse, elderly dependent, or a child under 18 who is in full-time education, depending on the circumstances.
- Gifts to charities or community amateur sports clubs, which are always tax-exempt.
- Gifts to political parties, provided certain conditions are met.
- Gifts from surplus income, as long as they are part of a regular pattern and do not reduce the donor’s standard of living.
It’s important to remember that gifting and tax is a complex area with intricate rules. Keeping detailed records of your gifts is essential, particularly for gifts from surplus income, as HMRC may require evidence of regularity and affordability to qualify for exemptions. As always, it’s best to consult a qualified professional if you’re at all unsure.
As we mentioned right at the start, there is a good chance that you may not have to deal with inheritance tax at all during your life. However, if you do, understanding how these tax mechanisms work will be essential to maximising the benefit of your inherited wealth.And here at Blacktower, we don’t just deal with UK inheritance laws. Instead, we work with expats in all the countries we operate in to help them get the most out of their tax planning and financing.
Disclaimer: The above information was correct at the time of preparation and does not constitute investment advice. You should seek advice from a professional regulated adviser before embarking on any financial planning activity.