Inheritance tax can feel like a complicated topic, but understanding how it works could make a big difference to the people you leave behind.
While not every estate will need to pay inheritance tax, it’s worth knowing the rules and what options you have to plan ahead. Taking action now could help reduce the tax your loved ones might face later.
In this guide, we’ll explain how inheritance tax works, who might need to pay it, and how life insurance can help protect your family from an unexpected bill.
Inheritance tax is a tax on the estate you leave behind when you pass away.
Your estate includes things like:
Property
Savings and cash
Investments
Valuable possessions, such as cars, jewellery, or collectables
Inheritance tax is usually only payable if the total value of your estate is above a certain threshold. Right now, that threshold is £325,000 - often called the nil-rate band. That means anything up to this amount can usually be passed on tax-free. Anything above £325,000 could be taxed at 40%.
If you’re married or in a civil partnership, anything you leave to your spouse or civil partner can usually be passed on without inheritance tax.
Any unused inheritance tax allowance can also normally be transferred to them, which could increase the amount they’re able to leave behind tax-free when they pass away.
For example, if you and your partner have an estate worth £500,000, if one of you dies, the surviving partner would usually inherit the full estate without paying inheritance tax.
Because the first partner’s £325,000 allowance hasn’t been used, it can be passed on to the surviving partner. This means that when they pass away, they could have a combined inheritance tax allowance of up to £650,000.
So, if the estate is still worth £500,000 at that point, there would usually be no inheritance tax to pay.
If you own a property and plan to leave it to your children - including adopted, foster or stepchildren - or grandchildren, you may be able to use an extra inheritance tax allowance called the main residence nil-rate band.
This is currently worth £175,000 and sits on top of the standard £325,000 inheritance tax allowance. That means you could potentially pass on up to £500,000 before inheritance tax applies.
If you’re married or in a civil partnership, both allowances can usually be combined. This could increase the total amount you’re able to pass on tax-free to up to £1 million (£325,000 x 2, plus £175,000 x 2).
To qualify for the full additional allowance, the property must have been your main home and your total estate must be worth less than £2 million.
For example, if you and your partner have an estate worth £1.5 million, including the home you live in, together, you could have a combined inheritance tax allowance of £1 million, including the property allowance.
This means the remaining £500,000 of your estate could be subject to inheritance tax. At 40%, that would result in a tax bill of £200,000.
Inheritance tax rules can be complex, especially when property and larger estates are involved. If you’re unsure how it might affect you, it’s worth speaking to an expert or seeking independent financial advice to understand your options.
Your estate includes more than just your home. Savings, investments, and other valuable assets all count too - and these can add up over time.
If your estate could be over the inheritance tax threshold, life insurance may be one way to help protect what you leave behind.
A whole of life insurance policy is often used for this. It’s designed to pay out when you die and can help your loved ones cover any inheritance tax bill, so they may not need to use savings or sell assets to pay it.
It’s important to know that a life insurance payout could also form part of your estate, which may mean it’s included when inheritance tax is calculated. One way to help avoid this is by putting your policy into trust. This can usually be arranged when you take out your policy and means the payout can go directly to your chosen beneficiaries, rather than becoming part of your estate. Because inheritance tax and trusts can be complex, it’s worth understanding your options and getting the right advice for your circumstances.
We can help explain how life insurance could fit into your estate planning, and if needed, point you towards independent financial advice for more specialist support.
Inheritance tax can feel complicated, but understanding the rules and planning ahead can make a real difference to the people you leave behind.
Life insurance can be one way to help cover a potential inheritance tax bill, and placing a policy into trust could help make sure the payout goes directly to your loved ones rather than forming part of your estate.
If you’re considering life insurance as part of your estate planning, it’s worth exploring your options carefully to make sure your cover fits your needs and circumstances. Get in touch with one of our expert advisers today.
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