Inheritance Tax (IHT) is a levy placed on an estate after someone has passed away. It can be a significant concern for many families when planning how to pass on their wealth to future generations. According to the Institute of Fiscal Studies (IFS), the proportion of estates liable for inheritance tax is set to rise to over 7% by 2032/33, with around one in eight people predicted to have inheritance tax due on their death or their spouses’ death.
After applying available tax reliefs, the amount of Inheritance Tax liable to an estate is calculated as the total value of their assets minus any outstanding debts. In the UK, this is levied at 40% on the portion of the estate that exceeds the nil-rate band of £325,000.
Inheritance Tax mitigation requires proactive steps to protect your wealth for future generations. This article will explore the various strategies to reduce your inheritance tax bill, including gifting, trusts, and donations. We will also examine the importance of making a will and explore joint asset ownership. By fully understanding the options available, you can take steps to minimise your inheritance tax liability.
Table of Contents
Utilise Gifting Exemptions
One of the most effective ways to reduce your inheritance liability is by making gifts during your lifetime. Assuming you survive for seven years after making a gift, it will be exempt from inheritance tax. According to HMRC’s guide to gifts, gifting can include:
- Money
- Household and personal goods
- Property, Land or Buildings
- Listed stocks and shares
- Unlisted shares held for less than 2 years before death
A gift can also include any money lost during the sale of an asset. For instance, if you sell your house to your child for less than its market value, the difference in value is considered a gift.
Anything you leave in your Will does not automatically count as a gift but will form part of your estate. In turn, the value of these assets is likely to form part of your inheritance tax liability.
Lifetime Gifts
Annual Gifts
Each year, you can give up to £3,000 worth of gifts inheritance tax-free from 6th April to 5th April. Any unused allowance can be carried forward to the next tax year, known as a “roll”. However, this can only be carried forward for one year only, known as the annual exemption. This £3,000 yearly allowance is determined on a per-person basis, meaning married couples, in theory, receive double the allowance.
Small Gifts
There is no limit on the number of small gifts you can make within a tax year, up to a limit of £250 per person. This exemption only applies, assuming you have not used other allowances on the same person.
Birthday or Christmas gifts from your regular income are exempt from inheritance tax calculations.
Wedding Gifts
You can make tax-free gifts to individuals getting married or entering a civil partnership. The gift must be given on or around the wedding date or civil ceremony. The amount you can give without forming part of your estate for inheritance tax depends on your relationship with the recipient. The allowances are as follows:
- Parents and Step-Parents: Up to £5,000
- Grandparents: Up to £2,500
- Other Relatives and Friends: Up to £1,000
Potentially Exempt Transfers (PETs)
A Potentially Exempt Transfer (PET) is a gift made within your lifetime that becomes exempt from inheritance tax, assuming you survive for seven years. When you make a PET, the gift is initially considered potentially exempt from inheritance tax. PETs are commonly used as part of estate inheritance tax planning and can help significantly reduce the tax liability on your estate after your death.
The 7-Year Rule for Gifts
If a gift is made to a relative or family member, and the gift giver lives for seven years after the transfer, it will be exempt from inheritance tax.
However, the remaining balance will form part of your taxable estate if you pass away during these seven years. In turn, the gift might become liable to inheritance tax once any remaining allowances are taken into consideration.
The value of the gift that forms part of the taxable estate is determined on a sliding scale, known as taper relief. Below is a breakdown of the tax payable on gifts that have not completed the seven-year transferable period, assuming nil-rate bands and any allowances have been exceeded:
| Years Passed | Taper Relief % | Tax Payable % |
|---|---|---|
| Less than 3 years | 0% | 40% |
| 3 to 4 years | 20% | 32% |
| 4 to 5 years | 40% | 24% |
| 5 to 6 years | 60% | 16% |
| 6 to 7 years | 80% | 8% |
| 7 years or more | 100% | 0% |
Example: If you transfer £100,000 to your child and pass away six years later. The gift will be subject to 8% IHT, assuming that inheritance allowances have been fully utilised, given the 80% taper relief. This will result in a tax liability of £8,000.
If the gift giver dies more than seven years after the date the gift was originally given, it will not form part of their taxable estate for IHT purposes.
Chargeable Lifetime Transfers (CLTs)
Chargeable Lifetime Transfers (CLTs) are gifts made during your lifetime that are immediately subject to inheritance tax. This does not necessarily mean that there is IHT to pay, but any CLT will be assessed to see if a charge to IHT will arise. If the amount gifted is within the available nil rate band, then no IHT will be due immediately.
CLTs are cumulative, meaning any CLTs made in the previous 7 years prior to the current CLT will reduce the amount of nil-rate band available. Any CLTs exceeding your nil-rate band allowance are subject to inheritance tax at 20%. This is payable at the time of transfer and is half the death rate applicable.
Types of CLT gifts include transfers to discretionary trusts and gifts to companies.
Example: You make a transfer of £400,000 into a discretionary trust. This exceeds the nil-rate band of £325,000. A 20% inheritance tax charge is payable at the time of transfer. If you pass away within seven years, an additional IHT tax of 20% may be liable on the qualifying amount.
If you wish to learn more about using trusts to reduce inheritance tax and its potential implications, read our dedicated article: Can a Trust Help Reduce Inheritance Tax?
Charitable and Political Donations
Charitable and political donations can significantly reduce your inheritance tax (IHT) liability while supporting causes you care about. Gifts to UK-registered charities and political parties are exempt from inheritance tax. If you leave at least 10% of your net estate to charity, the inheritance tax rate will be reduced from 40% to 36%. This is known as the 10% charitable donation rule.
Charitable donations can also be used in combination to help reduce taxable income. For more information, please read our article on How to Reduce Taxable Income as a High-earner in the UK.
Gifts out of excess income
Gifts made from your regular income, such as monthly payments to a family member, are exempt from inheritance tax, provided they do not affect your standard of living. These gifts must be part of your normal expenditure and must not come from accrued capital.
To claim the exemption for gifts out of excess income, you must keep detailed records, including bank statements and evidence of your income and expenditure. These records may need to be submitted with the IHT 403 form when your estate is being assessed for inheritance tax.
Life Insurance and Inheritance Tax
Life insurance policies written in trust are generally exempt from inheritance tax. The payout from the policy is not considered part of your estate so that it can be passed on to your beneficiaries tax-free.
If the life insurance policy is not written in trust, the payout may form part of your estate and be subject to inheritance tax. Ensuring your life insurance policies are correctly structured is important to avoid unnecessary tax liabilities.
Benefits of Making a Will
Writing a well-drafted and clear Will is paramount in estate planning and can help minimise your inheritance tax. Wills are an essential document detailing your personal wishes upon death and stating the beneficiaries of your estate. Intestacy rules will prevail without a Will, though this can often result in individuals contesting a Will.
For estates that exceed nil-rate allowances and are potentially liable to IHT, it is important to highlight whether assets must be entirely passed onto a married partner. This will depend on whether the assets are jointly owned or held in common. Assets left to a married partner are not liable to inheritance tax.
It is also advisable to consider setting up a Power of Attorney in conjunction with writing a Will. This provides legal responsibility to a nominated individual, who can legally take responsibility for your care and finances if you can no longer do so yourself. For more information about Power of Attorney, you can read HMRC: Lasting Power of Attorney.
Jointly Owned Property and Inheritance Tax
When a property is jointly owned, it can be held as either a joint tenancy or tenancy in common. In a joint tenancy, the property automatically passes to the surviving owner upon death. In a tenancy in common, each owner can leave their share of the property to a beneficiary of their choice.
If you own a share of a property, you may be eligible for a discount on the value of that share for inheritance tax purposes. The discount ranges between 10% and 20%, depending on the size of the share and the property’s marketability.
Conclusion
Inheritance tax can significantly reduce the amount of wealth passed on to your loved ones, but with careful planning, it is possible to mitigate or even avoid this tax. By understanding the various strategies available, such as gifting, trusts, and other estate planning tools, you can proactively protect your wealth for future generations.
It is important to be proactive and start estate planning early to ensure the transfer of assets to your beneficiary without incurring inheritance tax. By taking advantage of yearly tax-free gift allowances and initiating potentially exempt transfers (PETs) early, you can minimise future IHT liabilities on your estate.
At DS Burge & Co, we offer comprehensive, expert guidance on estate planning, trust arrangements and inheritance mitigation. If you’re concerned about safeguarding your wealth or how your assets might be taxed, contact one of our expert advisors, who can provide personalised advice tailored to your circumstances to ensure the maximum benefit for your next of kin.