Yahoo Finance EastEnders: How to avoid an inheritance tax bill
The BBC's EastEnders doesn’t often feature tax-related plot lines, which is probably for the best, but in recent weeks it has been grappling with the nightmares people can run into when they’re hit with a hefty inheritance tax (IHT) bill.
And while some Eastenders plots are ludicrously far-fetched, a version of this one will be playing out in homes across the UK as we speak.
It raises the question of whether it could happen to you or your loved ones, and what you can do about it.
When June Brown passed away last year, so did the character she played — Dot Cotton. Dot left her house in Walford to her step-granddaughter, Sonia Fowler. And because the value of London property is so eye-wateringly high, it generated an inheritance tax bill of £196,000.
Sonia could take a mortgage to cover the cost, and the fact she has taken in a lodger could help. Apparently it’s set to have hilarious consequences too, but for many people in this position, it’s no laughing matter, because they end up having to sell up to pay the tax bill.
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The good news is that at the moment, fewer than one in 20 people are subject to IHT. This is because you have a couple of allowances, which means the first chunk of money or property you inherit is free of tax.
The main allowance — called the nil rate band — is £325,000, and if you leave your property to children or grandchildren, you get another allowance called the residence nil rate band of £175,000.
If you’re married or in a civil partnership, then you could have even more. If on the first death you leave everything to your spouse, you’ll also leave them your IHT allowance. It means that on the second death, up to £1m could be tax free.
The bad news is that if you don’t leave your property to your children or grandchildren, you don’t get the residence nil rate band, and if your whole estate is worth more than £2m, it starts to taper away until at £2.25m it goes altogether.
And while all of these figures sound unimaginably large, it’s not impossible that house price rises could push you into the realms of paying tax.
The average property price was up almost £63,000 in the three years to November 2022 to around £295,0000, and the average price of a London property has hit £542,000.
In the meantime, those tax-free bands haven’t changed — and they’re frozen until at least 2028. Once you bust the limits you have to pay tax at 40%, and in the tax year 2021/22 IHT hit a record high of £6.1bn.
It means it’s worth considering whether you could end up with an IHT bill when members of your family pass away — or whether you could leave one behind for your children. If it’s a risk, there are some steps that can help.
One approach is for older people to give things away while they’re still alive. We all have a gift allowance of £3,000 each year that falls out of our estate immediately for IHT purposes, and while it’s annoying that this limit hasn’t risen for four decades, it’s better than nothing. They can also give small gifts of up to £250, specific gifts for family weddings and regular gifts from their income.
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They can make gifts of any size — known as potentially exempt transfers — and as long as they live for at least seven years after handing it over, it falls outside of their estate for IHT purposes.
However, anyone starting to think they could give their home away and dodge tax needs to be very clear about the rules. If they continue to live in it or benefit from it in any way, it won’t be counted as having been given away at all. So they’ll have paid for the legalities of swapping ownership without any benefit.
If they’re worried about giving away things they may need later, a useful alternative is life insurance, where the payout will cover the tax bill. This should be written in trust, so it falls outside of their estate, and there’s no IHT to pay on it.
For some people, the kinds of sums involved seem too large to ever be a problem, but we can’t predict what we’ll have built up by the time we pass away, or what the tax rules will be at the time, so it’s worth considering the possibilities. Dot Cotton probably never gave it a second thought — which is why Sonia’s in trouble now.
Sarah Coles is a personal finance analyst at Hargreaves Lansdown and co-presents Switch Your Money On podcast.
Watch: What is inheritance tax?
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