Inheritance tax (IHT) is a significant consideration when planning the future of your estate. Without effective tax planning, a large portion of your family wealth could go towards paying an inheritance tax bill rather than benefiting your loved ones. In this guide, we explore key strategies to minimize your IHT liability and ensure that the total value of your estate is passed on efficiently.
Understanding Inheritance Tax (IHT)
Inheritance tax is charged on the estate of a deceased person when the estate is above the inheritance tax threshold. The standard nil rate band (tax free threshold) is £325,000 per person, so anything above this will be taxed at 40%. But there are exemptions and allowances to reduce your IHT bill.
If your estate includes your family home and is passing to a direct descendant (a child or grandchild) you may be eligible for the residence nil rate band which adds £175,000 to the tax free threshold, so married couples can pass on up to £1 million tax free when combining allowances.
How to Reduce Your Inheritance Tax Liability
To avoid inheritance tax and reduce the tax on your estate, try:
1. Making Gifts to Reduce the Value of Your Estate
- Outright gifts: Give away assets and reduce the taxable estate over time.
- Potentially exempt transfers (PETs): If you survive more than 7 years after making a gift, it’s IHT free.
- Sliding scale (taper relief): If you die within 7 years, the tax bill is reduced based on how long you’ve survived.
- Some gifts are tax free, including:
- Annual exemption: You can give away £3,000 per tax year tax free.
- Small gifts exemption: You can give up to £250 per person per year.
- Wedding gifts: Tax free up to £5,000 for a child, £2,500 for a grandchild, £1,000 for others.
2. Trusts for Inheritance Tax Planning
Placing assets in a trust takes them out of the estate so beneficiaries get them without increasing their IHT liability. Options include:
- Bare trusts – simple and usually tax efficient.
- Discretionary trusts – allow flexibility but have their own tax implications.
- Life interest trusts – provide income to a surviving partner and preserve the estate for future generations.
3. Leaving Money to Charity
Donations to registered charities are IHT free. And if you leave at least 10% of your estate to charity the IHT rate on the rest of your estate is reduced from 40% to 36%.
4. Life Insurance to Cover Your IHT Bill
A whole of life policy, written in trust, means your beneficiaries get a lump sum to cover the IHT bill so they don’t have to sell property or other assets to pay IHT.
5. Use the Available Nil Rate Band and Residence Nil Rate Band
- If your estate is above the nil rate band, unused nil rate band allowances from a spouse or civil partner can be transferred.
- The residence nil rate band applies if you pass your main residence to direct descendants.
6. Business Relief and Agricultural Relief
If you have a business or agricultural land, you may be eligible for business relief or agricultural relief which can reduce the estate value by up to 100%.
What Happens If You Do Nothing?
Without proper planning your named executor will have to pay IHT from your estate before assets are distributed. Estates above the nil rate band threshold will be potentially IHT liable. This could mean selling assets, including the family home, to cover the costs.
What is the Taxable Estate and How Does it Affect Your IHT Bill
When calculating your IHT bill HMRC looks at the total value of your estate which includes your cash, property, family home, other assets and even certain gifts made in the seven years before death. If the estate is above the IHT threshold the IHT liability applies to the amount above the nil rate band.
Your named executor will need to value your estate and work out how much IHT is due. This will involve considering any available nil rate band, unused nil rate band from a spouse or civil partner and any business relief or agricultural relief that may apply.
How Married Couples and Civil Partners Can Minimise Their Tax Bill
If you are married or in a civil partnership you can transfer any unused nil rate band to your surviving partner and effectively double the tax free threshold for your family wealth. If one partner doesn’t use their nil rate band or residence nil rate band the remaining amount can be transferred and will reduce the IHT bill for the estate.
Assets passed between married couples or civil partners are IHT free so no IHT liability is incurred when the first partner dies. But when the surviving partner dies the combined estate value will be assessed for IHT purposes so tax planning is essential.
Taper Relief and the Gift Sliding Scale
If you are planning to gift money to your beneficiaries you need to understand the seven year rule. Potentially exempt transfers (PETs) are IHT free if you survive for more than seven years after the gift. If you die within this period a sliding scale known as taper relief applies and the tax reduces gradually depending on how many years have passed since the gift was made.
The taper relief rates are:
- 0-3 years: 40% (full IHT applies)
- 3-4 years: 32%
- 4-5 years: 24%
- 5-6 years: 16%
- 6-7 years: 8%
- 7+ years: 0% (tax-free)
The sooner you start gifting the more chance you have of avoiding IHT on those assets.
Using Allowances to Minimise Your IHT Bill
There are several allowances to help reduce your IHT bill. These include the annual gift allowance, the residence nil rate band and business relief for qualifying businesses. If you own a permanent home that qualifies for the main residence exemption and pass it to a direct descendant you can reduce the IHT by a significant amount.
Working with a financial adviser will help you use these tax free allowances and structure your estate in the best possible way.
How to Pay IHT and Manage Your IHT Bill
When someone dies their named executor is responsible for paying any IHT before they can distribute the estate to the beneficiaries. Normally the IHT bill must be paid within 6 months of the person’s death or interest will be charged on the outstanding amount.
If there are not enough liquid assets in the estate to pay the IHT bill the executor may need to take a short term loan, use assets such as property to raise funds or pay IHT in instalments if the estate includes illiquid assets such as property. Proper inheritance tax planning beforehand can avoid this financial pressure and ensure your family wealth is preserved for future generations.
IHT on Property and Your Home
One of the biggest considerations in inheritance tax planning is the home, as property is often a large part of an individual’s taxable estate. If the estate exceeds the IHT threshold the main residence may be IHT liable if it is not passed to a direct descendant.
For homeowners the residence nil rate band provides an additional tax free allowance when passing the home to children or grandchildren. But if the total value of the estate exceeds £2 million this allowance is gradually withdrawn so high value estates may lose out on this tax relief. In these cases working with a financial adviser can help structure the estate to retain this tax benefit.
How Business Owners Can Minimise Their IHT Bill
For business owners business relief is one of the best ways to reduce IHT exposure. If a business meets the qualifying conditions up to 100% of its value can be exempt for IHT purposes and so reduce the tax bill on the estate.
To qualify for business relief the business must be trading and have been owned for at least 2 years before death. However some assets within a business such as investment properties may not be eligible for relief. Seeking professional estate planning advice is key to ensure your business is structured to maximise IHT savings.
IHT for Expats and Non-Residents
If you live abroad but have UK based assets you may still be IHT liable in the UK. IHT liability is based on domicile status so even if you are a non-UK resident your worldwide estate could still be IHT liable if you are deemed to be domiciled in the UK for IHT purposes.
Expats may need to take additional tax planning measures such as re-structuring their estate, using trusts or making outright gifts to reduce their IHT exposure. If you are unsure about your IHT status contact MPG Solicitors for advice to ensure your wealth is managed properly.
Review Your Estate Plan Regularly
Tax laws and IHT regulations change so a strategy that works today may not work in the future. Reviewing your estate and making adjustments to keep up with the latest tax allowances and exemptions will avoid unexpected IHT liability.
Also changes in your life such as marriage, entering a civil partnership, divorce, having children or acquiring new assets can affect how your IHT is calculated. Keeping your estate plan up to date will ensure your beneficiaries get the value of your estate in the most tax efficient way possible.
Final Thoughts: Why You Should Get Professional Financial Advice
Inheritance tax planning can be complicated. By getting estate planning advice from experts like MPG Solicitors you can create a strategy to reduce your IHT liability and maximise the benefits for your beneficiaries. Whether you need to pay IHT efficiently, structure tax free gifts or make the most of exemptions your estate will be handled properly.
