Expat guide to UK inheritance tax

It is expected that by 2021, the UK taxman will collect GBP5.7 billion per annum from inheritance tax (IHT).

You shouldn’t think that, because you are an expat, this doesn’t concern you.

Domicile is not the same as residence

If you, or your father, were born or raised in the UK, then you are likely to be deemed domiciled in the UK and this means that your worldwide assets are of interest to HMRC when it comes to IHT.

UK inheritance tax for expats is chargeable on their worldwide assets, at a rate of 40% of the amount by which the total value of their worldwide estate exceeds the nil rate band, which is GBP325,000 in the current tax year for individuals or GBP650,000 per married couple.

It has been stuck at this level for a number of years

There is also a residence nil rate band which can be applied to property. This will rise to an additional GBP175,000 per person in tax year 2020/2021.

Things subject to IHT

  • Cash
  • ISAs
  • Most investments
  • Property
  • Vehicles
  • Life insurance payouts (where the policy is not written in trust).

Things not subject to IHT

  • Pensions
  • Certain qualifying investments

What happens if assets are passed to a spouse on death?

As long as the spouse has UK domicile, then all assets can be passed to them without an IHT liability.

Inheritance tax when passing assets to a non-UK domiciled spouse

Lifetime and on-death transfers between spouses/civil partners who are both UK domiciled are exempt from UK inheritance tax (IHT). However, what happens when one of the parties is not UK domiciled?

In such a case, special rules apply whereby the non domiciled spouse/civil partner could receive up to £825,000 (tax year 20/2018) tax free from their late spouse/civil partner. This would be made up of the following:

  • £325,000 nil rate band
  • £175,000 residence nil rate band
  • £325,000 inter-spouse exemption

Anything in excess of this would then be subject to UK inheritance tax at 40%.

It should be noted that individuals who are UK domiciled are liable to inheritance tax on worldwide assets.

One solution would be for the non-domiciled spouse/civil partner to choose to be treated as UK domiciled for inheritance tax purposes.

The benefit of this course of action would be that they would then be treated in the same was as a domiciled spouse/civil partner. I.e. the transfer would be exempt from IHT, irrespective of amount.

The downside is that on the death of the non-domiciled party, their full estate (including assets outside the UK) would then be liable for UK inheritance tax. In addition, a decision to be treated as UK domiciled for inheritance tax purposes is irrevocable.

[IHT] is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.

– Roy Jenkin

What happens if a full allowance is not used?

The non used part of an allowance can be transferred to a spouse (as long as the spouse has UK domicile).

For example,  on death, Bob has an estate worth GBP800,000. He passes this to his wife, Fiona. As Fiona has UK domicile, there is no IHT to pay and therefore none of Bob’s allowance is used.

Fiona will then inherit 100 percent of Bob’s GBP325,000 allowance, meaning that she now has an allowance of GBP650,000.

What about a main residence?

It will be covered by the Residence Nil Rate Band (RNRB).

This applies to a family home (or proceeds from the sale if a family home) going to direct descendants only.

It is also worth noting that it applies to property anywhere in the world, not just the UK.

This allowance is £175,000.

Ultimately, this means that married couples will be able to use their combined allowances to pass estates worth up to GBP1 million onto their direct descendants.

3 simple yet effective solutions that expats can use to mitigate the negative implications of inheritance tax

1. Give assets away while you are still alive

You can gift assets to anyone and as long as you survive for 7 years afterwards, your gift will be free of inheritance tax.

If you do not survive 7 years, then, depending on whether your nil rate band has been used up, there could be inheritance tax due on the gift.

2. Your pension can be your biggest inheritance tax break

If you have sufficient assets elsewhere, then the best use of a pension might well be to leave it untouched and pass it on to your heirs.

The reason for this, is that pensions fall outside of a person’s estate for inheritance tax purposes.

How does it work?

Pensions were never treated in quite the same way as the rest of a person’s estate for inheritance tax purposes. They fell outside the estate but, until reforms introduced in 2015, they attracted a high rate of tax on their owner’s death.

Then George Osborne’s reforms ended that system.

Now, if the pension is a UK registered scheme (e.g. SIPP or personal pension), then where the owner of the assets is 75 or older on death, their heir would pay tax on the money only when drawn, at his or her respective rate of income tax.

If the owner died pre age  75 then their heir would have no tax pay.

If the scheme is an overseas pension scheme (QROPS) and the owner of the assets was not resident in the UK then their heir would have no UK tax to pay on the money, irrespective of whether the owner died before 75 or after.

Who could  benefit?

If you have property and other wealth that means your estate is likely to incur death duties, and if you have money in a “defined contribution” or “pension pot” style pension, then you could take advantage.

Conclusion

By keeping your pension intact and using your other assets to cover  your living costs in retirement, you can reduce your inheritance tax bill by passing on the pension free of  UK inheritance tax.

3. Life insurance policy in trust

You could set up a whole of life insurance policy with a sum assured equivalent to the expected IHT on your estate.

If you put the policy in trust with your executors as beneficiaries, then the payment on death will not be subject to IHT.

In addition, as the payout does not form part of your estate, it will not have to go through probate, meaning that it can be used to pay the IHT due without delay.

What is probate?

A grant of probate is the legal permission that is needed in order to access and distribute someone’s estate when they die. 

On death, assets (property, pensions, investments and savings) can be frozen. In order to free up these assets (the estate), probate is needed.

Contrary to popular belief, any inheritance tax due on an estate needs to be paid before a grant of probate gives access to the deceased’s estate. 

In fact, the court will not grant probate until it receives a stamped receipt from the tax office showing that the tax has been paid.

Different financial services institutions have different limits that dictate when probate is required, and this will depend on the value of the assets in question. 

In many cases, a financial firm will need sight of probate before they can release someone’s holdings. 

Tip

One solution that would make life easier would be for anyone whose estate is likely to be subject to IHT to take out a life insurance policy and put that policy in trust with their executors as beneficiary.

They could set the sum assured at the level of the expected tax bill and due it being in trust, the proceeds would go straight to the executors without needing to go through probate, allowing them to pay the IHT.

IHT rules in your country of residence

As an expat living outside the UK, you will also need to familiarise your self with the rules around inheritance/estate tax in your country of residence and any associated double taxation treaty.

You should consult a local tax adviser to do so.

In addition, if any of your intended beneficiaries are not resident in the UK, you should take into account the rules in their country.

While in the UK, inheritance tax is paid by the estate of the deceased, in some countries it is the beneficiary that is taxed.

Read more:

HMRC Residence, Domicile and Remittance Basis Manual


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By Ross Naylor

Ross has been a financial adviser for the past 26 years. He uses the experience that he has gained over this time to help busy expats to understand their options, make smart decisions and avoid costly mistakes.