Five simple steps to reduce your Inheritance Tax Bill

Sharon Bonfield shares her top tips and what you need to know about navigating IHT.
piggy bank reduce your inheritance tax bill

How do you reduce your Inheritance Tax Bill? is a question that is asked of every financial adviser in the land. Inheritance Tax (IHT) brings in a significant income for the Government, yet with increases in property prices, more people are being caught by the IHT threshold. IHT receipts received by HMRC during the tax year 2020-2021 came to £5.4 billion and have remained around that level for the past four years, according to official statistics1.

Despite this, so much of the tax paid on the value of your estate after you die is avoidable. With careful planning to ensure full use of exemptions, gifting and other tax-efficient investments, you can mitigate and minimise much of the IHT you would otherwise pay.

Assets are subject to IHT at the standard rate of 40% after the first £325000. This includes your family home, bank accounts, ISAs, jewellery, art and antiques.

Without utilising these exemptions and allowances, you could significantly reduce what you are able to pass on to loved ones. Here, I share my top advice and what you need to know about navigating IHT.

Understand the value of advice

There is no set age for when you should start planning – and it differs for each person – but it will often begin at a point when your savings and assets begin to accumulate. This might coincide with children becoming less financially dependent and mortgage payments reducing or disappearing.

You’re not expected to know every rule, exemption and allowance and how to use them – IHT is a highly complex area.

Therefore taking advice can help mitigate your IHT as part of broader planning for later life that also includes retirement income, planning for social care, giving money away when you’re alive and passing it on when you’re no longer here.

Formulating a plan helps you to take action and reduces the chances of a nasty tax surprise.  

IHT thresholds and rates can vary

IHT thresholds differ depending on the scenario. Understanding these can instantly minimise a big chunk of what your IHT bill is likely to be.

  • If you leave everything above that threshold to your spouse, civil partner, a charity or a community amateur sports club, there is no IHT to be paid, even above £325000
  • If you want to pass on your family home to your children or grandchildren you may also be entitled to an additional allowance known as the Residence Nil Rate Band. The HMRC rules on this are very complex so it makes sense to seek advice from a regulated financial advisor to help you understand whether you would qualify.
  • A reduced IHT rate of 36% is payable on certain assets if you give away 10% or more of the net value of your estate to charity.

Look to gifting as a way to reduce your Inheritance Tax Bill

You can give away up to £3000 each tax year (your ‘annual exemption’), as well as make any number of small gifts up to £250 per person, and not incur IHT. This is a good way of supporting your family whilst reducing your IHT liability.

Almost all gifts become IHT exempt if you survive for seven years. These are the main factors to consider:

  • Gifts to your spouse or civil partner are exempt from tax during your lifetime, or upon death.
  • A tax-free allowance of up to £3000 applies to gifts made to other beneficiaries. You can carry the allowance over for one tax year, meaning you could give away up to £6000 in a tax year.
  • You can give up to £5000 to a child or £2500 to a grandchild to pay for a wedding or civil partnership. This is exempt from IHT and is considered separate to the £3000 annual exemption. This is a good way to pass on some of the value of your estate in the form of a gift you would probably have made anyway.
  • Gifts made regularly from your income can potentially be tax free, as long as you can prove they do not diminish your own standard of living.
  • Gifts above the allowance are exempt from IHT if you survive for seven years after making the gift. Gifts above the nil rate band, made between three and seven years before your death are taxed on a sliding scale – known as ‘taper relief’. The longer the time, the less you pay.

Pensions could be considered free from IHT

If you’re looking for a tax-efficient way to pass on wealth, pensions could form part of the solution. Most Defined Contribution schemes will fall outside of your estate.

You may have multiple pension pots so you could choose to pass one or more to your children or grandchildren.

Your pension pot can be paid as a lump sum to any beneficiary, free from tax, if you die before you are 75. After 75, beneficiaries will need to pay tax at their marginal rate on withdrawals.

Consider a trust

Trusts are an effective way to ensure the right people get the right money at the right time. They remain a traditional part of IHT planning.

There are several different types of trust and ways of setting them up. Some trusts allow you access to the funds whilst others do not.

Trusts can be complex, so it’s best to seek advice in this area before you begin the process of setting one up.

The value of an investment with St James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Trusts are not regulated by the Financial Conduct Authority or the Prudential Regulation Authority.

1 Inheritance Tax statistics: commentary, HMRC National Statistics, updated 29 July 2021

All thresholds, rules and allowances are for 2021-22 tax year.

For further reading on IHT click here.

If you found Five steps to reduce your Inheritance Tax Bill helpful, you can read more by Sharon Bonfield here.

Tags: , , Last modified: December 9, 2021

Written by 11:45 am Tax, Finance