5 ways to avoid being caught out by Inheritance Tax

Inheritance Tax (IHT) is one of Britain’s most disliked taxes, as it can severely reduce the amount of wealth that your loved ones will receive on your death.

In fact, according to FTAdviser, the average IHT bill in the 2019/20 tax year was £216,000. It is predicted that this could rise to £266,000 by 2022/23.

The standard rate of IHT is 40% of your money and applies to assets above a tax-free threshold called the “nil-rate band” (NRB). As of the 2022/23 tax year, the NRB is £325,000.

You may also benefit from an additional residence nil-rate band (RNRB) of £175,000 if you pass your main residence to your direct descendants, such as your children or grandchildren. In combination, these thresholds can allow you to pass on up to £500,000 tax-free.

Additionally, if you’re married or in a civil partnership, you can also pass on any unused NRB or RNRB to your partner on your death, or vice versa if you outlive your spouse/civil partner. That means you may be able to pass on up to £1 million without incurring a tax charge.

It’s important to note that, if your total estate is worth £2 million or more, your RNRB will be tapered by £1 for every £2 over that threshold. That means, if your estate is worth more than £2.35 million (or £2.7 million where two RNRBs are available), your RNRB could taper away entirely.

However, any value in your estate above these amounts will be subject to a 40% tax charge, which can eat into your children or grandchildren’s inheritance.

That’s why it can be sensible to consider strategies that mitigate IHT, potentially reducing your tax bill and ensuring that your family receive as much of your wealth as possible.

Here are five strategies you may be able to use to avoid being caught out by IHT.

1. Gifting

Gifting money or assets to reduce the size of your estate is one of the favoured ways to avoid paying IHT in the UK.

Each tax year, you have a number of tax-free gifting exemptions, which allow you to give money away without it being included in the value of your estate. For the 2022/23 tax year, the annual exemption is £3,000. You can carry forward one year’s worth of unused annual exemption, meaning you can make use of it in the following tax year if you have any left from the previous one – but you must fully use the current year’s allowance in order to do so.

Similarly, you can make unlimited £250 gifts to whomever you’d like, but not to the same person(s) who received any larger gift from you.

Additionally, you have a gifting allowance for weddings and civil partnerships, depending on how you know the individuals getting married. You can gift up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to any other person you know who’s getting married, with this money falling outside the value of your estate.

You can also make regular gifts of any surplus income you have.

As these allowances are for each individual, your spouse or partner will also have them if you’re married or in a civil partnership. This effectively means that each allowance is doubled.

On top of these exemptions, you can, in theory, make a gift of any size to an individual and have it fall outside the value of your estate, provided that you survive the gift by seven years or more.

If you die within these seven years, the full value of the gift will have used up some or all of the nil rate band available to your estate on death. In addition, should the gift (alone or cumulatively) exceed your available nil rate band, IHT is payable by the recipient of the gift on the excess above the nil rate band.

The recipient’s IHT rate will depend on something called “taper relief”. The table below shows how the rate of IHT changes depending on how soon you die after making your gift:






It’s worth noting that taper relief only applies to amounts that exceed your NRB. So, for example, if you made a gift of £300,000 and died six years later, this gift will simply use up some of your NRB and will therefore not be subject to taper relief.

But, if you gifted £400,000, this would exceed your NRB by £75,000 (assuming you only had one nil rate band available on your death). As a result, only this £75,000 would be subject to the taper. The RNRB does not apply here as that amount only relates to your property, not to other assets and can’t be used in relation to lifetime gifts.

Provided that you do so carefully, gifting money can have the dual impact of getting your wealth into your chosen beneficiaries’ hands during your lifetime, while also reducing the size of your estate so there’s even more left for them on your death.

2. Making tax-efficient investments

When your executors come to calculate the value of your estate, your investments will be included in that total, even those contained within ISAs (apart from ISAs that qualify for business relief).

But certain tax-efficient investments can reduce your IHT liability if you include them in your portfolio.

For example, investments in most Enterprise Investment Schemes (EISs) or qualifying companies listed on the Alternative Investment Market (AIM) are entirely free from IHT, provided that you’ve held them for two years or more on your death and they have remained qualifying.

So, you could consider including some of these investments in your portfolio to avoid paying IHT.

Bear in mind that these investments do tend to carry greater risk than other options, as EISs and AIM-listed companies tend to be more likely to fail than companies on a mainstream index.

Speak to a financial planner if you’re considering this type of investment as rules can also change, meaning your investments may become subject to IHT in future.

3. Using trusts

Trusts can be a useful estate planning tool to both protect your wealth and reduce an IHT bill.

When you put money or assets in trust, you essentially lock it away for an intended recipient, known as the “beneficiary”. You then appoint a “trustee” to oversee the trust who will give the beneficiary access to the trust at a time of your choosing.

While trusts are useful for ringfencing wealth, they can also be tax efficient. This is because IHT for wealth in certain types of trusts may be calculated in a different way to that of the rest of your estate.

As a result, using these trusts can help with IHT and estate planning, while still giving the settlor relevant degrees of control.

The tax rules around trusts can be complicated, so it’s often best to work with a planner and trust expert if you’re considering this option.

4. Donate to charity in your will

You can reduce the size of your estate and your rate of IHT by making charitable donations in your will.

The government will reduce your IHT rate to 36% on your taxable estate if you donate at least 10% of your total estate to charity in your will. The gift to charity is itself exempt from IHT.

Choosing this method allows you to support a good cause while also reducing your IHT bill.

5. Take income tax-efficiently in retirement

If you’ve used as many methods as possible to reduce the size of your estate, another option you could consider is how you draw your income in retirement.

For example, while investments and savings will count towards the value of your estate, usually your pension will not.

So, if you chose to live off your investments and savings while leaving your pension where it is, your family may be able to inherit your pension fund without having to pay an IHT bill.

Make sure you take financial advice if you’re considering doing this as you may have other tax considerations to keep an eye on, such as Capital Gains Tax (CGT).

Work with us

If you’d like to find the best strategies for reducing a potential IHT bill and ensuring those you love benefit the most from all your hard work, then please speak to us at Bowmore Financial Planning.

We can provide personalised advice on the best strategies that are most suitable for you and your family in your specific circumstances.

Email enquiries@bowmorefp.com or call 01275 462 469 to find out more.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available.  Your pension income could also be affected by the interest rates at the time you take your benefits.

The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.

Bowmore Financial Planning Ltd is not regulated to provide tax advice

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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