Inheritance tax (IHT) in the UK is a tax on the estate of a deceased person when the value of their assets exceeds certain thresholds. It is widely rumoured that the rates of IHT will increase and thresholds will change when Rachel Reeves delivers her first Budget on October 30th.
For many, this could be a significant financial burden, reducing the amount of inheritance they receive. However, with careful estate planning and use of legal mechanisms, it is possible to minimise or even eliminate IHT liability. IHT is the only tax that you can legitimately defeat – but this requires proactive steps.
Here, we outline key strategies to defeat IHT legally.
- IHT Thresholds
Before diving into strategies, it’s important to understand the basics of inheritance tax. As of October 2024, IHT is charged at 40% on the value of an estate above the nil-rate band (NRB), which is £325,000. This means that the first £325,000 of an estate is exempt from IHT, and anything above that threshold is taxed at 40%. This amount is doubled to £650,000 for married couples.
In addition, there is a residence nil-rate band (RNRB), which can provide an additional allowance when a residence is passed on to direct descendants (children or grandchildren). This stands at £175,000, potentially increasing the total tax-free allowance to £500,000 for individuals, or up to £1 million for married couples.
The Budget is likely to amend these thresholds. We will publish our estate planning guidance once we know of the government’s plans on 30th October.
- Gifts
One of the most effective ways to reduce the taxable value of your estate is to give away assets during your lifetime. These gifts can potentially be exempt from inheritance tax if structured correctly:
- Annual exemption: Individuals can give away up to £3,000 each year without incurring inheritance tax. If unused, this exemption can be carried forward for one year.
- Small gift exemption: You can give up to £250 to any number of people each tax year without affecting your IHT liability.
- Potentially exempt transfers (PETs): Larger gifts are considered PETs, meaning if you survive for seven years after making the gift, it becomes fully exempt from inheritance tax. However, if you die within seven years, the gift may still be taxed, though at a reduced rate if you survive between three to seven years.
- Wedding gifts: You can gift up to £5,000 to your child, £2,500 to a grandchild, or £1,000 to anyone else as a wedding gift, all tax-free.
Gifting is also likely to be affected by the Budget with a lifetime limit being mentioned. Again, we will be updating our guidance as soon as the Budget is delivered.
- Trusts
Trusts are a powerful tool in estate planning and can help mitigate IHT. By placing assets into a trust, you effectively remove them from your estate, if certain conditions are met. Trusts are also useful for protecting assets; such as shares in a family business or investments.
Using trusts requires careful planning and professional advice, as the tax implications can vary depending on the type of trust and the value of assets involved.
- Pensions
Pension savings in the UK are generally free from IHT, making them an ideal vehicle for passing on wealth. If you die before the age of 75, your beneficiaries can inherit your pension pot tax-free. After the age of 75, they will pay income tax on withdrawals at their marginal rate, but no IHT will be due. One strategy is to use other savings or investments during your retirement and leave your pension pot intact to pass on to your beneficiaries tax-efficiently.
- Leave Money to Charity
Donations to UK-registered charities are exempt from inheritance tax. If you leave at least 10% of your estate to charity, the rate of inheritance tax on the rest of your estate will reduce from 40% to 36%. Not only does this benefit charitable causes, but it also lessens the tax burden on your estate.
- Business and Agricultural Property
Certain types of property, such as agricultural land or shares in a private trading company, may qualify for business property relief (BPR) or agricultural property relief (APR). BPR can reduce the value of business assets by up to 100% for IHT purposes, allowing business owners to pass on their businesses tax-free.
You will need to seek our advice to see if either of these reliefs are available to you.
- Life Insurance Policies
Taking out a life insurance policy to cover the potential IHT bill is a common way to protect your beneficiaries from a large financial hit. However, it is important that the policy is written in trust otherwise the payout may itself be subject to IHT.
- Joint Ownership of Assets
When it comes to property, joint ownership structures such as tenancy in common or joint tenancy can affect how your estate is treated for tax purposes. For instance, under joint tenancy, the surviving co-owner automatically inherits the property without it being included in the deceased’s estate for IHT purposes.
Seek professional advice
IHT can be a significant burden, but with proactive estate planning, you can minimise or eliminate this liability for your beneficiaries. Utilising gifts, trusts, charitable donations and other reliefs available under UK law can greatly reduce the impact of IHT.
We can help ensure that your estate plans are both tax-efficient and legally compliant. It is vital to seek advice at the first opportunity. The impending budget may amend some of the figures and thresholds mentioned in this article, but the underlying message will remain the same – be proactive, plan ahead and seek professional advice.