Inheritance tax (IHT) is often referred to as a voluntary tax. This doesn’t mean you can avoid paying tax where it’s due, but there are ways you can reduce inheritance tax, in some cases to nil, by planning ahead.

IHT receipts in the UK hit a record high of £7.1bn in the 2022/23 tax year. This number is expected to increase over the coming years due to rising house prices and because the thresholds at which you start paying inheritance tax are frozen until 2028.

If you are looking at ways to reduce your inheritance tax liability, and leave more money to your loved ones, this article explores some of the options you could consider.

What is inheritance tax?

Inheritance tax is charged on estates worth more than £325,000 per person. If you are a homeowner and plan to leave your property to direct descendants, you could get a further allowance of up to £175,000 (known as the residence nil-rate band or RNRB).

IHT is not charged on gifts or assets passed between married couples or civil partners on death.

Couples that are married or in a civil partnership can combine their allowances, meaning their total estate can be worth up to £1m before inheritance tax is due. Your estate includes everything from the family home to ISAs and other savings (although pensions are separate from your estate).

IHT currently stands at a hefty rate of 40% for the value of your estate that is over the inheritance tax threshold. And if your estate is worth more than £2m, the amount of relief available for the family home through the RNRB will taper by £1 for every £2 of value above the taper threshold.

So, if you have a significant amount of wealth, you can look at ways to make your portfolio as tax efficient as possible and this may include the below.

Gifting

You can give away money or assets in your lifetime to reduce the value of your estate. For example, you may want to give money to your children to help them buy a home.

IHT will not be charged if you die after seven years of making the gift.

If you die within seven years, the value of the gift will be deducted from your £325,000 tax-free allowance.  Any inheritance tax due on gifts is therefore usually paid by the estate, unless you give away more than £325,000 in gifts in the 7 years before your death. Once you’ve given away more than £325,000, anyone who gets a gift from you in those 7 years will have to pay inheritance tax on their gift, the amount of which will depend on when you gave the gift.

You can give away small amounts each tax year without worrying about inheritance tax. In total, you can give away £3,000 worth of assets or money and this is known as the annual exemption. For example, if you have two children you could give them £1,500 each. If you don’t use your full £3,000 annual exemption in one year, you can ‘carry over’ the remainder and use it the following year. However, you can only use this carry-over for one year. Birthday or Christmas gifts given from your regular income do not count.

You can also make small gifts to anyone each year of up to £250 per person. Meanwhile larger one-off gifts can be made to someone who is getting married or having a civil partnership. See more on inheritance tax and gifting on the government’s website.

Giving money away through income

You may be able to make gifts out of surplus income that will not be liable for future inheritance tax.

For example, regular payments may be made to help your child pay rent or to pay for a grandchild’s school fees. These payments would not count towards the £3,000 annual gift exemption and there is no limit to how much you can give tax-free.

For money to count as coming out of regular income, you must prove you can afford the payments without reducing your standard of living.

Pensions

Money saved into a pension will likely fall outside your estate and is therefore free of inheritance tax.

If you have a defined contribution pension, any money that’s left in your pension when you die can be passed on to your family without an inheritance tax charge. However, if you die after the age of 75, your beneficiaries may have to pay income tax on withdrawals from the pension. If you die before the age of 75, the money can be withdrawn tax-free.

If you have a defined benefit or final salary pension, check the scheme’s rules for detail on how the pension can be passed to a nominated beneficiary.

Putting money in a trust

If you set up a trust, you hand over money or assets to someone else to look after on a third individual’s behalf. For example, you might put savings for your grandchildren into a trust that they can access when they are older.

When assets are put into a trust, they no longer belong to you, so the beneficiaries may not have to pay IHT. But trusts are complicated to navigate, and it is worth seeking specialist advice.

Trusts are also typically set up when taking out a life insurance policy. Putting a life insurance policy into a trust means the payout may not be subject to IHT if you pass away during the term of the policy.

Business relief

Money invested in companies that qualify for business relief (BR) will become zero-rated for IHT once the investment has been held for two years. The investment must also be held until death, at which time it should pass on free from inheritance tax.

Shares in companies that qualify for BR can, therefore, be passed on free from IHT if they've been held for at least two years and you are still an investor in them at the time of death.

There are a number of ways to get access to BR. The vast majority of people will access business relief by investing in an estate planning service or BR-focused investment product that provides access to a package of investment opportunities - for example, the service or product may invest in AIM-listed share that qualify for BR, or it may invest in certain types of private companies.

The benefit of an estate planning service is that you retain access to your money, without having to give it away to other individuals to reduce the value of your estate, while targeting a steady return that can help to grow your wealth as well.

However, investing in companies that qualify for BR is a high-risk investment strategy and individuals should only consider it after speaking to a regulated financial adviser.  

In summary

It's never too early to consider IHT planning. The reality is that many people don’t realise they have an inheritance tax issue until it is too late. If your home is worth more than £1m, your children and loved ones will almost certainly face paying inheritance tax of 40% on the total value of assets in your estate over that amount.

This can cause confusion and financial stress at an emotional time. But with a bit of careful planning, there are ways to reduce the inheritance tax bill and plan for it effectively.  

‍

This article is for UK residents interested in finding out more about Business Relief and the ProVen Estate Planning Service strategies. UK tax rules and regulations are subject to change, and such changes may be retrospective. Your ability to obtain tax reliefs will depend on your personal circumstances. It is not our intention to offer legal, tax or investment advice, and we always recommend that investors seek professional advice that can take account of their personal circumstances before making any investment or estate planning decisions. An investment in the ProVen Estate Planning Service should be considered high risk and past performance is not a good indicator of future results.

Important notice: issued by Beringea LLP of Charter House, 55 Drury Lane, London, England WC2B 5SQ, registered in England & Wales number OC342919 and authorised and regulated by the Financial Conduct Authority, number 496358.