5 common IHT scenarios - from best to worst

Inheritance tax, or IHT, is one of the UK’s most fiendishly complicated taxes. One person can have the same amount of wealth as another, but find their heirs are paying hugely different sums based on their family situation.

Here we run through five common scenarios, from best to worst, and how much IHT would be payable in each case. We assume that, in each situation, there is a property worth £500,000 and savings and investments worth £500,000 - giving them a total estate value of £1 million.

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1. The married couple

Robert and Tash are married with a son, Tony. When one of them dies, they leave everything to the survivor. When the second one of them dies, the estate would pass to Tony. In tax terms, you say the estate, not the beneficiary i.e. Tony claims exemptions. So, here, the estate can claim both of Tony's parents’ exemptions - so 2 x the nil rate band of £325,000 and 2 x the main residence nil rate band of £175,000, or £1 million in total.

Total amount that can be passed on tax-free: £1 million.

Amount of estate subject to IHT of 40%: zero.

IHT payable: zero.

2. The widowed aunt

Magda is widowed with no children. When her husband died, she inherited everything. As transfers to spouses are exempt, none of her husband’s £325,000 nil rate band was used. On her death, she passes on all her wealth to her niece.

Her estate can claim 2 x the nil rate band (£650,000) but not the main residence nil rate band because this is only available to direct descendants - i.e. children or grandchildren.

Total amount that can be passed on tax-free: £650,000.

Amount of estate subject to IHT of 40%: £350,000.

IHT payable: £140,000.

3. The single mother

Susan is single with one daughter, Amy, and has a home worth £500,000 with no mortgage. On death, her estate can claim the nil rate band of £325,000 and the main residence nil rate band of £175,000.

Total amount that can be passed on tax-free: £500,000.

Amount of estate subject to IHT of 40%: £500,000.

IHT payable: £200,000.

4. The unmarried uncle

John is single with no children and wants to pass all his wealth onto his niece.

On death, his estate can claim the nil rate band of £325,000 but not the main residence nil rate band, as this is only available to direct descendants.

Total amount that can be passed on tax-free: £325,000.

Amount of estate subject to IHT of 40%: £675,000.

IHT payable: £270,000.

5. The unmarried couple

Shiva and Anya have been together for 20 years, but they are not married or civil partners and have no children. Unfortunately for them, only married couples and civil partners can pass all their estate to their surviving partner tax-free under the IHT spouse exemption. 

Shiva dies first and passes on half the value of their property and savings (£500,000 in total) to Anya.

Shiva is not married and has no children and so only the £325,000 nil rate band exemption is available.

This leaves £175,000 subject to tax at 40%, meaning an IHT liability of £70,000.

After the tax has been paid out of Shiva's estate, Anya will inherit the house and the remaining money as long as there is a will in place bequeathing these assets to her. If Shiva died with no will, Anya may get nothing and be forced to sell the home to pay half the value into Shiva’s estate for distribution.

This assumes Shiva and Anya were tenants in common (rather than join tenants) of the house.

When Anya dies, her estate will pass to relatives as the couple had no children. Anya’s executors will be able to use her nil rate band, but she cannot use Shiva’s, so the maximum she can pass on tax-free is £325,000.

Assuming the estate value is now £930,000 after paying Shiva’s £70,000 IHT bill:

Total amount that can be passed on tax-free: £325,000.

Amount of estate subject to IHT of 40%: £605,000.

IHT payable: £242,000 (or £312,000 if you include Shiva’s IHT bill).

The estate has suffered a degree of double taxation, as part of Shiva’s estate was taxable when he died. Anya inherited those assets, which again suffered tax on her death.

How to pass on £2 million IHT-free

Whether you’re married, unmarried, have kids or not, there are various gifting allowances you can make use of to reduce your IHT liability.

When combined, these could allow you to pass on significant sums.

Take, for example, a married couple with three children. Using the two best-known allowances (nil rate band and main residence nil rate band), they could pass on a £500,000 home and £500,000 in savings and investments tax-free to their children, so £1 million in total.

However, during their lifetime they could also make gifts. Depending on which gifting allowance is used, some of these will immediately fall outside of estate calculations for IHT purposes.

The below gifts are immediately exempt:

• Up to £3,000 per tax year using the annual gift allowance
• Up to £5,000 per child for a wedding (the amount is slightly less for grandchildren or other people)
• A potentially unlimited amount so long as the gifts are made on a regular basis out of their monthly income, and they can afford the payments after meeting their usual living costs. This is known as ‘normal expenditure out of income’.

You can also give away a potentially unlimited amount via direct gifts, but you must live another seven years after making the gift for it to be exempt.

For example, that couple could give away using these gifting rules:

• £5,000 each to three children as wedding gifts - £15,000 in total
• £250,000 each to three 3 children for house deposits more than 7 years before death - £750,000 in total
• £3,000 per month towards grandchildren’s nursery/school fees over six years using the ‘normal expenditure out of income’ rule - £216,000 in total
• £3,000 each year over six years using the annual gifting allowance - £18,000 in total
• £1,000 per year for six years on Christmas and birthday gifts, also using the ‘normal expenditure out of income’ rule - £6,000 in total

This would enable them to pass on an additional £1.005 million to their family IHT (more than £2 million in total), so long as they could prove that their gifts complied with HM Revenue & Customs’ rules.

• Read: 5 tax hacks: how to make financial gifts without a big tax bill

It is important to keep accurate records, particularly if trying to claim under the ‘normal expenditure out of income’ allowance.

Of course, this is an extreme scenario, and many families will not be able to give away so much. But it is helpful in highlighting how generous the allowances can be if you make use of them.

This article is for general information only and does not constitute tax advice.

Inheritance tax is an extremely complicated area of financial planning and, if you’re unsure of anything, it’s best to speak to a financial adviser or a professional tax adviser.

If you’ve got a burning question you want to ask, why not drop us a line?  Ask us your question.

• Read: Autumn Budget: inheritance tax and other possible changes
• Read: Inheritance tax changes - what we know so far
• More on passing on wealth

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