Ways To Reduce Potential Inheritance Tax

Russell Burns

5 mins

Ways To Reduce Potential Inheritance Tax

Inheritance tax (IHT) used to affect only the wealthy but is increasingly affecting a larger number of families, partly thanks to rising house prices. Before thinking about reducing your inheritance tax, however, your main concern should be ensuring you have enough savings to look after yourself in your lifetime.

How does inheritance tax work?

When you pass away, assets left to a surviving spouse or civil partner don’t attract any inheritance tax.

If, when you pass away, the value of your estate – that’s your property, money, and possessions – exceeds £325,000 (a.k.a. the “nil-band rate”, NRB), it’ll attract inheritance tax at a 40% rate. That said, the NRB can transfer to your spouse or civil partner when you pass away, giving a couple a total of £650,000 before attracting IHT.

There’s also a “residence nil-rate band” (RNRB) worth being aware of: it’s an allowance of up to £175,000 inheritance tax free relating to your primary residence if it’s passed onto direct descendants like children and grandchildren.

Both your NRB and RNRB can be transferred to your partner, so there is potentially a total of £1 million (£325,000 x 2)+ (£175,000 x 2) available in inheritance tax exemptions.

Ways to reduce inheritance tax

Financial advisors often provide a free introductory meeting to discuss inheritance tax planning. Here are some areas to consider that could help you get started.

  • Gifting is one of the most straightforward ways to reduce your potential inheritance tax liability as regular gifts of surplus income are immediately exempt from any IHT. (Surplus income is defined as any income remaining after all regular outgoings are paid.) Crucially, the gifts must not impact the gift-giver’s standard of living and come from income rather than from selling down investments.
  • Potentially Exempt Transfers (PETs) take advantage of the seven-year rule, whereby a gift is no longer considered to be part of a person’s estate for inheritance tax purposes if the donor lives for seven years after making the gift. If the donor passes away between three and seven years after the gift, “taper relief” can reduce the total amount of inheritance tax payable.
Taper relief for gifts
Taper relief for gifts. Source HMRC.

Note that if the gift has increased in value since the original purchase, it may attract capital gains tax, eating into potential IHT savings. And that gifts you continue to benefit from – like gifting your home but continuing to live in it – are a “gift with reservation”, which remain part of your estate for inheritance tax purposes.

  • Equity release is an interesting way to potentially lower your inheritance tax bill. Your home is likely to be your most valuable asset and there are two ways you can unlock value from it: one is by freeing up cash to spend or gift with the hope of living at least seven years to reduce future inheritance tax. Another is, given inheritance tax is calculated on the total value of your estate – which includes assets and debts – the amount of equity released is treated as debt and is therefore offset against the value of your remaining assets, reducing the total value of your estate.
  • Trusts can also be used to reduce inheritance tax as assets stop belonging to their previous owner once placed into a trust – and assets within a trust don’t count towards the value of your estate.

A wide range of trusts can be used in inheritance tax planning, all with different advantages depending on your family circumstances:

  • Discretionary trusts allow the trustees to choose payment and income schedules for the beneficiary
  • Interest in possession trusts ensure one beneficiary will receive all the trust income.
  • Discounted gift trusts allow a settlor to give away assets but still receive regular payments for life.

Setting up trusts requires specialist advice as many are complex, including some having immediate tax implications, so you should consult with your solicitor and independent financial advisor.

Other gifts that are free from inheritance tax:

  • Gifts up to £3,000 in a single tax year.
  • If you get married or enter a civil partnership, you can gift £5,000 to your child, £2,500 to a grandchild, and £1,000 to any other person to commemorate the event.
  • Up to £250 to any number of different people.
  • Gifts to UK-registered charities, political parties, and national institutions like museums and universities.
  • Gifts between spouses are usually exempt, but there is a limit if the spouse is non-domiciled.

Holding exempt assets

Business relief from inheritance tax is available if you own a business, have an interest in a business, shares in an unlisted company – as well as shares in certain AIM-listed companies. Relief is also available on certain land, buildings, and machinery used in the business. Relief can be either at 100% or 50%, depending on various factors.

To qualify, the person must have owned the business or assets for at least two years before passing away – and excludes companies that mainly deal with securities, stocks, shares, land, or buildings, excluding landlords for example.

Agricultural property relief lets you pass on some agricultural property that has been owned for at least two years free of IHT either during your lifetime or as part of your will. The relief is either at 50% or 100%. Agricultural property that qualifies includes land or pasture that is used to grow crops or to rear animals.

You may be able to get business relief on a transfer of agricultural property (e.g. farmland, buildings, or farm equipment) that isn’t eligible for agricultural relief. Taking professional advice here could help as the rules are complex and subject to change.



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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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