For certain assets, HMRC will allow Personal Representatives (PRs) to pay their Inheritance Tax bill in equal annual instalments over 10 years, referred to as the instalment option. This can be very useful where an estate is asset rich and cash poor, giving PRs time to free up cash to meet the tax bill. The instalment option is only available on qualifying property, broadly speaking land and business assets, and, unless the assets fall within very specific exceptions, HMRC will charge interest on the outstanding IHT. The instalment option is also lost on the sale of the said asset.
The first instalment of 10% must be paid by the end of the 6th month after the deceased’s death. The further nine instalments are paid annually from that date. Assuming the instalments are paid on time, there is no interest on the first instalment but on each later instalment you must pay interest on the full outstanding tax balance. (Note, if instalments are paid late there is further penalty interest payable).
The interest rate varies over time. From an all-time low of 0% in 2009, the interest rate has been steadily increasing and, as of 11 October 2022, is now 4.75% (a jump from 2.6% in January 2022). Given the historically low interest rates over the past 13 years, it was an easy decision to take the instalment option given that increases in property value and other investments would more than likely offset the interest payable to HMRC. However, with further increases to the Bank of England base rate expected in the coming months, paying by instalment may no longer present the best option.
By way of example, if the PRs do not want to sell the deceased’s home worth £1m then the instalment option would be available. Ignoring reliefs and exemptions, the estate would have an IHT bill of £400,000 (as IHT is charged at 40%). The first instalment of £40,000 would be payable within 6 months of the deceased’s death and no interest would be payable. However on the second instalment, interest would be payable on the entire outstanding balance of £360,000. At the current interest rate of 4.75%, the second instalment would total £57,100, of which £17,100 would be interest. This would continue with each subsequent instalment, so that (assuming the interest rate remains unchanged) the total interest paid could be £85,500 by the time the 10th and final instalment is paid.
Ending the instalment option
If you have already opted for the instalment option and are now facing increasing interest payments, it is not too late to limit these charges. PRs can elect to end the instalment option by making full payment of the IHT owed under the instalment option.
Please don’t hesitate to contact our probate team for advice on meeting your IHT bill and/or on interest.
With the Inheritance Tax interest rate likely to continue its upward trend, Personal Representatives currently paying the instalment option should be looking to pay off their outstanding Inheritance Tax bill as soon as possible to minimise their tax bill