How to avoid inheritance tax (IHT) in the UK

IHT is one of the more punitive taxes, weighing in at a hefty 40%, twice the rate of basic income tax. There is a tax-free allowance of £325,000 available.

Since this is less than the value of many UK family homes, this is supplemented by the residence nil-rate band (RNRB) that grants an additional tax-free £175,000. This additional allowance is only available if you pass on your home to direct descendants like your son, daughter or grandchildren.

The problem is property prices have soared over the last few decades, and most taxes increase the better off you are. With the higher tax brackets, you even start to lose some allowances.

The upshot is that a tax originally designed for the super-wealthy is used for widespread taxation.

So the question for many people is: how can I pay less inheritance tax?

How can I pay less inheritance tax?

There are many strategies for reducing or avoiding your IHT liability.

 Here’s a quick overview of your options.

1. Using your gift allowances

The IHT rules allow you to give some gifts completely free of IHT and put them outside your estate immediately for inheritance tax purposes.

You can make gifts of £3,000 in total per year out of your saved assets to an individual or several people, free of inheritance tax.

You can carry any unused annual allowance forward to the next tax year only.

You’re also allowed to give away £250 each tax year to any number of people, as long as you haven’t used another allowance on the same person.

You can also give regular gifts from your excess income - income you’re not relying on for your cost of living. It makes sense to get advice here, as the rules are complicated.

Strict record-keeping is a must to keep track of all these gifts.

2. Giving your money away early

If you can afford it, then it can make sense to give away money or assets early.

Any gifts you make, over and above the allowances, may be counted as part of your estate if you die within seven years of the gift. This means there may be additional IHT to pay based on the value of these gifts. These gifts are known as potentially exempt transfers (PETs).

3. Life insurance

Life insurance can be an effective way to cover an IHT bill if you are in good health when you set it up.

You take out cover and place it in trust, so the payout falls outside of your estate, and on your death, it’s available to pay any IHT bill.

4. Make charitable donations

Gifts to charity are exempt from IHT and will immediately pass outside your estate, even if you die within seven years.

Gifts from your estate can reduce the overall rate you pay IHT (from 40% to 36%). To achieve this, you’ll have to give at least 10% of your net estate to charity, although the rules are complex, so it’s important to get advice.

5. Move abroad

If you’re thinking about moving abroad, then leaving the UK may affect your IHT bill. The rules for IHT are determined by your domicile status so make sure you take advice and understand the tax rules both in the UK and where you are moving. 

You’ll also need to be careful about visiting the UK or keeping property here, as HMRC may consider that you’re still resident or domiciled in the UK.

6. Making a tax efficient will

Making a tax-efficient will is one of the best ways to save inheritance tax. A specialist solicitor will be able to make sure you make use of all your available exemptions.

For example, it’s possible to lose your residence nil rate band if you leave assets to someone who is not a direct descendent.

What are the rules for IHT on pensions?

The rules for IHT on pensions are changing. Inherited pensions are currently free from IHT, but the UK government plans to introduce IHT on inherited pensions from April 2027.

This is a significant change and could mean your loved ones end up paying a lot more inheritance tax, particularly if you have a large pension pot.

It’s important to get advice on how the changes might affect you.

Conclusion

In summary, understanding the rules could help reduce your IHT bill by using your exemptions.

This is only a quickfire summary of potentially complex situations full of caveats, traps and pitfalls.

Therefore, if any of this might apply to you, you should seek professional financial advice.

Unbiased can quickly connect you to a qualified local financial adviser who can look at your circumstances and figure out how you can reduce a potential inheritance tax bill.

If you found this article helpful, you might also find our article on inheritance tax business property relief informative.