How to avoid inheritance tax (IHT) in the UK

Is inheritance tax the most unpopular tax?

Independent financial adviser at S Johnson Wealth Management, Steve Johnson, offers his tips on how to avoid inheritance tax (IHT) for those who feel they have already been ‘taxed to death.’

 IHT is one of the more punitive taxes, weighing in at a hefty 40%, twice the rate of basic income tax.

Having scored ‘nil points’ in the popularity contest, IHT offers a nil-rate band (NRB) that allows the first £325,000 of a person’s estate to be inherited tax-free.

Since this is roughly equal to a very small property in Greater London, this was followed by the residence nil-rate band (RNRB) that grants an additional tax-free £175,000 in the 2023/24 tax year.

The problem is that 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.

It’s also a postcode lottery, given how wildly property prices vary throughout the country.

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. Gift allowances

You can make gifts of £3,000 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.

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

2. Give some or all of your money away

You can make larger gifts of money, provided you stay alive for the next seven years, which is not always easy. These are called potentially exempt transfers (PETs).

The good news is, there’s no limit to the size of this kind of gift.

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 under trust, so the payout falls outside of your estate, and on your death, it clears any IHT bill.

However, you must pay the premiums on the policy out of your normal income.

4. Use your pension freedoms

Pension freedoms have been with us since 2015, but not enough people use them to their full extent.

If you have a private pension fund, this method can work really well. You do your best not to spend all your pension funds before you die (for example, by living off other assets as far as possible).

Then, when you die, any unspent fund will pass tax-free to your kids or grandkids if you have set things up properly. Your money can, therefore, cascade down the generations.

Remember: you don’t use your will to do this! Pensions don’t form part of your normal estate, so you need to make your wishes clear with each pension provider.

5. Make charitable donations

Making gifts to charity will reduce the size of your taxable estate– but even better, it can reduce the overall rate you pay IHT (from 40% to 36%).

Remember that to achieve this, you’ll have to give at least 10% of your net estate to charity.

6. Move abroad

Leaving the UK can work to reduce IHT, but beware of leaping out of the frying pan and into the fire.

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.

Conclusion

In summary, your options to avoid or reduce your inheritance tax are: spend it, gift it, stick it in your pension, send it to charity, set up insurance and trust, or emigrate.

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.