How to avoid paying Inheritance Tax on your estate when you pass away

9 February 2022

Inheritance Tax (IHT) is often called “Britain’s most hated tax” – and for good reason. Charged at a rate of 40% on the value of your estate above the applicable nil-rate bands when you pass away, it can make a significant dent in the wealth you pass on to loved ones when you die.

And, as property prices rise and the IHT nil-rate bands remain frozen, more and more people are finding their estate liable for IHT.

Indeed, FTAdviser reports that IHT receipts for April to November 2021 were £4.1 billion, a rise of £600 million compared with the same period in 2020, according to the latest set of official figures. That’s a 17% increase year-on-year.

Considering the chancellor has frozen the threshold over which IHT is due until 2026, it’s likely that many more estates will pay IHT in the future. So, if you want to reduce your liability and pass more of your wealth to loved ones, here are three strategies to consider.

1. Make use of the nil-rate bands

Each individual has an IHT nil-rate band, meaning that the tax is only due on the value of your estate above this band. Your estate includes the value of assets you hold, such as investments, property, shares, ISAs, bonds, cash and so on. Interestingly, it typically won’t include the value of any pensions.

In the 2021/22 tax year, and frozen until 2026, the nil-rate band is £325,000. So, if the value of your estate is below this amount when you pass away, no IHT will typically be due.

In addition to the nil-rate band, if you plan to pass your home to a child or grandchild you can make use of the additional “residence nil-rate band”. This allows you to pass on up to £175,000 of property tax-free.

Read more about the residence nil-rate band in our helpful blog.

It’s useful to note that, if the value of your entire estate is more than £2 million, the residence nil-rate band is reduced by £1 for every £2 of value by which the estate value exceeds the £2 million threshold.

It’s also worth remembering that, if you’re married or in a civil partnership, you can pass on any unused allowance from the nil-rate band and residence nil-rate band to your partner. So, as a couple, you can usually pass on up to £1 million without IHT being due.

Writing a will can help you make the most of your nil-rate bands. For instance, leaving your home to your children means you’re able to make use of the residence nil-rate band.

2. Use the gifting allowances

Gifting can be a great way to reduce the value of your estate. There are several gifting exemptions available, which mean that money you gift falls outside your estate for IHT purposes.

Just remember that gifting will typically mean you lose control of the money, so you should only gift what you can afford.

Your annual exemption

You can gift up to £3,000 each tax year (2021/22) and this money will not form part of your estate for IHT purposes. This is an individual exemption and so, as a couple, you can normally gift up to £6,000 a year.

You can only use your annual exemption once each tax year.

You can carry forward any unused exemption for one year. So, if you didn’t use your exemption in the 2020/21 tax year, you could each gift a total of £6,000 now, or £12,000 as a couple.

Small gifts

Any gift you make of up to £250 is excluded from your estate for Inheritance Tax purposes (as long as the gift is to someone who hasn’t received your £3,000 exempted gift).

For example, if you have eight grandchildren, you could gift each of them £250 on their birthday each year and it would not be counted as part of your estate.

Wedding gifts

You can make a gift to a couple on the event of their wedding or civil partnership and this will fall outside your estate for IHT purposes.

You can gift up to:

You must make the gift before the wedding, and the wedding must take place.

Gifts to charity

Giving money to charity can be a good way of reducing the amount of IHT that you pay. Any cash or physical asset you leave to a qualifying charity, either during your lifetime or in your will, is exempt from IHT.

Gifting to charity can reduce the amount of Inheritance Tax you pay in two ways:

Gifting to charity can be a win/win as you can help good causes while also reducing a potential tax liability.

3. Make more significant gifts – perhaps from income

Under IHT rules, it’s worth remembering that you can make a gift to anyone. Providing you live more than seven years from when you make the gift, it will fall outside of your estate for Inheritance Tax purposes.

When you make a gift, it becomes a potentially exempt transfer (PET). Assuming you live for a further seven years, there will not be any IHT due on it.

If you die within seven years of making the gift it becomes a Chargeable Transfer, and some tax may be payable. The amount of tax will depend on several factors, including the total value of gifts and how long after making the gift you pass away.

An additional way to reduce a possible IHT liability is to make gifts from your income.

If you have surplus income for your needs, the IHT rules allow an exemption for “normal expenditure out of income”. For example, you might pay the school fees of grandchildren or make regular deposits to pay for the living costs of your children.

For this exemption to apply you must meet three conditions:

This exemption can sometimes be difficult to claim, and so it is important that you keep careful and accurate records. You’ll need to retain supporting evidence, and it can be beneficial to document your intent to make regular gifts in writing and show how they assist with living costs.

Get in touch

If you would like to explore how you can mitigate a potential IHT liability, please get in touch. Email or call 0161 8080200.

Please note

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

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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