Meeting an inheritance tax liability
It is often quoted by the government that less than 4% of estates are subject to inheritance tax. However, this number is starting to increase year-on-year and is forecast to be over 7% by 2032-33.
The increase in the number of estates subject to inheritance tax is due in part to the rapid growth in wealth of older people (the Silent Generation (1925-1945) and Baby Boomers (1946-1964)) and in part to the freezing of inheritance tax reliefs and allowances. The nil rate band (NRB) has been frozen at £325,000 since 2009 and the residence nil rate band (RNRB) at £175,000 since 2021. Both are scheduled to remain frozen at these levels until at least April 2028.
Whilst the number of estates may appear small, those that are subject to inheritance tax can, however, face substantial liabilities running into hundreds of thousands of pounds.
The term ‘personal representatives’ is used below to describe both executors (where an individual dies with a valid will) and administrators (where an individual dies intestate (without a valid will)).
When is inheritance tax due?
Inheritance tax is due 6 months after the date of death. If payment has not been made in full, HMRC can start charging interest on the outstanding amount. Interest is charged at 2.5% above the Bank of England base rate. However, it is important to remember that the deceased’s personal representatives may not have full control over when an inheritance tax payment can be made.
It is worth remembering that, in order to make a payment of inheritance tax to HMRC, an inheritance tax reference number is required. This should be applied for at least 3 weeks before the intended date of payment. It can be applied for online or by completing form IHT422.
Grants of probate and letters of administration
The time that it takes for a grant of probate (where the deceased died with a valid will) or letters of administration (where the deceased died intestate) to be issued has increased over recent years. It is also not possible to obtain probate until the inheritance tax liability has been settled with HMRC.
However, as the personal representatives’ legal capacity is not confirmed until probate (or administration) is granted, they are, generally, unable to sell assets in the deceased’s estate to, for example, raise sufficient cash to meet the inheritance tax liability. This conundrum is often referred to as a ‘Gordian Knot’.
The Direct Payment Scheme
In recognition of the problems faced by the deceased’s personal representatives, the government introduced the Direct Payment Scheme a few years ago. This allows banks, building societies and National Savings & Investments (NS&I) to make direct payments to HMRC from the deceased’s accounts to meet inheritance tax liabilities to allow probate to be granted. It is applied for by competing form IHT423 (a separate form is required for each account).
It may also be possible to sell shares with the funds passed to HMRC under the Direct Payment Scheme.
Other ways to pay
Banks and financial institutions may be prepared to release funds to the deceased’s personal representatives, outside of the Direct Payment Scheme, before probate (or administration) is granted. However, limits apply to the amounts that may be released, with each institution setting its own limits, so it may not be possible to raise the required amount using this route.
Personal representatives may also settle the estate’s inheritance tax liabilities using their own resources (if available). The amounts paid can then be reclaimed from the deceased’s estate or beneficiaries once probate (or administration) is granted.
Banks, in the past, offered probate or executor loans, but these are now much harder to find. Specialist lenders offer short term loans but the interest rates charged may be high.
Planning before death
Where shares and funds are held on a platform or under a nominee arrangement, it may be possible for the individual to instruct the platform provider or nominee to sell shares or funds ahead of probate to meet inheritance tax liabilities.
Where cash is held in, say, bank or building society accounts, the individual could consider placing this cash into a joint account(s) with their proposed personal representative or a close relation – on the individual’s death, the legal ownership of the account passes to the personal representative or relation, although the beneficial ownership of the cash remains with the deceased individual. The surviving personal representative can then draw the funds down to meet the inheritance tax liability.
The same outcome can be achieved by establishing a ‘living trust’ or probate trust. The individual is a beneficiary of this trust and can therefore benefit from the assets placed into the trust during their lifetime, although the legal ownership of the assets passes to the trustees. The assets held in such arrangements remain part of the individual’s estate for inheritance tax purposes (as they can continue to benefit from the assets) but will not form part of the estate for probate (or administration) purposes so could be accessed by the individual’s personal representatives after their death to fund inheritance tax and other estate liabilities (such as funeral costs etc).
If the individual owns assets held in an overseas jurisdiction, these may become subject to probate in that jurisdiction on the individual’s death. Holding foreign assets in a living or probate trust may then shield these assets from foreign probate as the trustees (the legal owners) remain alive after the individual’s death. Again, these assets may then be available to the deceased’s personal representatives to meet inheritance tax and other estate liabilities.
Using life assurance to fund inheritance tax liabilities
Effecting a life assurance policy which is then placed into a trust for the benefit of the deceased’s estate beneficiaries can be an efficient route to provide sufficient funds to meet an inheritance tax liability. The life assurance policy would typically be a whole of life policy either written on a single life basis or, where the individual’s will provides that their assets will pass to their surviving spouse or civil partner, on a joint life last survivor (second death) basis.
As the policy is held in trust, it does not form part of the deceased’s estate and is not subject to UK probate. The trustees can apply for payment of the death benefits from the life assurance company and distribute these to the trust beneficiaries when received.
Paying inheritance tax in instalments
Where estate assets comprise of property, land or certain qualifying shares, personal representatives can apply to HMRC, via form IHT400, to pay the inheritance tax in instalments over up to 10 years. The first instalment is due six months after the date of the individual’s death. Subsequent instalments will be subject to interest charges from HMRC (as will the first instalment if it is paid late).
The outstanding balance of the inheritance tax due can be repaid at any time but will become due immediately if the assets are sold.
A deceased’s personal representatives may have many other duties to perform after an individual’s death. Trying to raise funds to meet an inheritance tax liability may be an additional burden so it can make sense to try to arrange, during one’s lifetime, that funds will in place to meet any potential inheritance tax liabilities on death.