How to pay inheritance tax during probate (and avoid sky-high interest)

Tens of thousands of families are forced to pay inheritance tax on their loved one’s estate every year. If you are one of them, then you will have to pay this huge bill within six months of the date of death, otherwise the tax office will start charging interest.

When rates were low, interest on late payments was not such a big deal. However, because HM Revenue and Customs (HMRC) sets its interest rate 2.5 percentage points above that of the Bank of England, relentless rate rises mean families are now being charged a punitive 7pc – due to rise to 7.5pc from 11 July.

This is adding thousands of pounds to families’ bills. In the first six months of 2021, when the interest rate was 2.6pc, a family with a £100,000 inheritance tax bill would have racked up interest charges worth £1,292.

However, a family facing the same bill in the first six months of 2023 would have owed more than double that – £3,232 – according to HMRC’s interest rate calculator.

The bigger the bill, the more interest you will pay. Kieran Bowe of law firm Russell Cooke said: “I have clients with high-value estates who are currently being charged £1,000 a day.”

Families are doing everything they can to avoid paying these extortionate charges. The trouble is that how early or late they pay their inheritance tax bill is not always within their control.

The significant jump in interest rates has coincided with a huge increase in waiting times for grants of probate. This is the document that’s required for the executor to sell certain assets, like property, and administer the estate among the beneficiaries.

It is now taking over two months on average to get a grant of probate. In some cases, families are being left waiting for almost a year. 

The massive delays – which are particularly bad for those with more complex probate applications – have been blamed on a sharp fall in the number of experienced staff and a shift to online probate services during 2019. 

Without a grant, executors can find themselves in limbo, unable to pay death duties, and stacking up huge interest charges as a result. “We are now urging clients to act quickly to avoid falling into the trap,” said Mr Bowe. 

Here, Telegraph Money outlines your options if you have to pay inheritance tax on a loved one’s estate. 

When do I need to pay inheritance tax? 

One of the most frustrating elements of administering someone’s estate is that inheritance tax must be paid before you can apply for a grant of probate.

This may seem baffling and counterintuitive. After all, some assets in an estate cannot be sold without a grant of probate, such as the property of the deceased. What if, until the house is sold, the family does not have the funds to cover the inheritance tax bill? 

Fortunately, there are a number of options available to you. 

The first steps

If you have been made the executor of the estate, the first thing you must do – regardless of whether IHT is owed or not – is value the deceased’s assets.

This will involve getting the property valued, and combing through their financial accounts to find out how many gifts they made in the seven years before they died. This in itself can take a long time, especially if the estate is more complicated, so it is important to get started early. 

If there is inheritance tax to pay, you will need to get an Inheritance Tax reference number from HMRC at least three weeks before you make a payment, you can either do this online or by filling in and posting form IHT422. 

You must then start paying the bill. You’ll need to wait 20 working days after sending the tax forms before applying for probate.

Pay with the estate’s assets 

The most straightforward way to pay IHT is with the estate’s liquid assets. Banks and financial institutions will often release funds early to cover the payment of IHT. This is called the direct payment scheme.

Fill in form IHT423 and state the IHT reference number, the account details of the deceased and the amount to be transferred. This should be sent to the bank or building society who will then make the payment directly to HMRC. 

If the deceased is tied up in investments, stockbrokers can sometimes be given instructions to sell and release the funds to HMRC – also using the direct payment scheme. 

You might occasionally be able to sell high-value items, such as paintings, in order to pay the IHT, as these do not always require a grant of probate. 

Under the direct payment scheme, the bank should release all the funds needed to pay the inheritance tax bill, without probate.

If funds need to be released for another reason, the bank will usually cap the amount. These limits vary from bank to bank:

Pay from your own bank account

If the funds in the deceased’s account are not sufficient to cover the bill, then you may need to pay it out of your own savings.

Remember, you can then claim the money back from the deceased’s estate or the beneficiaries once you get a grant of probate.

What if I don’t know how much the estate is worth?

If you are having trouble valuing the estate, it may be worth paying at least some of the bill early, in order to reduce or avoid the interest. This is known as a “payment on account”. 

If you overpay, then HMRC will refund you once probate has been granted. It will also refund the interest you have overpaid on the amount. However, frustratingly, the interest it will pay you is lower than the interest you will be charged on late payments (currently 3.5pc, as opposed to 7pc).

To receive the refund, you need to write to HMRC’s Inheritance Tax team and put “Repayment – further details” at the top of the letter.

Pay in instalments

 Pay in instalments Where there are assets in the estate that take time to sell – such as property and investments – the inheritance tax bill can be paid in equal annual instalments over 10 years. It may also be possible to pay in instalments if you can show HMRC that paying in one lump sum will cause you financial hardship.

The executors must state on form IHT400 if they wish to pay inheritance tax in instalments. You can clear the outstanding balance at any time. Once the assets are sold, then the inheritance tax must be paid in full.

When paying in instalments, the first one will be due at the end of the sixth month after the death. Interest is not charged on the first payment unless it is late, however after that you will start paying interest. This is why it is better to avoid paying in instalments if you can. 

Inheritance tax loan

In the worst case scenario, you can take out a short-term loan to cover the bill, using your own assets or those of the estate as security. 

But this is not recommended because you will be charged interest on the loan – at about 1.4pc to 1.9pc per month. 

Mr Bowe said: “In the past, banks would offer probate loans or executor loans, but this market has closed down. Now specialist lenders offer loans that are very similar to bridging finance. If you take this option, it’s advised you only borrow what you need.”