How to mitigate your Inheritance Tax bill

At a glance

• Nobody wants a large Inheritance Tax (IHT) bill to be the biggest legacy they leave behind. But changes in the 2024 Autumn Budget to the rules around unspent pensions has left many people reconsidering their IHT planning.
• Gifting, both one-off lump sums, and regular gifts out of income, or life assurance are several options for mitigating your IHT liability and reducing your IHT tax bill.
• Starting your IHT planning early and taking financial advice can have a direct impact on your family’s financial wellbeing after you’re gone.

Nobody likes talking about death, and many of us aren’t that keen to talk about money either. So, it’s not surprising that many of us put our estate planning, and IHT in particular, on a back burner. Last year’s Autumn Budget however initiated widescale changes in the treatment of pensions, and IHT liability. From 2027, you will no longer be able to pass on an unspent private pension tax free. Which means many families may now be caught in the IHT net, and liable for up to 40% tax on some of their estate.

Not surprisingly, this has left many people urgently reassessing how they can transfer wealth to the next generation.

We may not enjoy talking about death, or taxes, but one thing’s for certain. Nobody wants to pay any more Inheritance Tax than they have to.

What is Inheritance Tax and how is it charged?

Inheritance Tax is currently charged at 40% of the value of your estate, over £325,000. But you can also claim an extra allowance, known as the Residence Nil Rate Band (RNRB), of up to £175,000 if you’re passing your main residential property on to a direct descendant. A direct descendant is a child, grandchild or lineal descendant of the person who has died. You can claim the RNRB allowance as long as your total estate is less than £2 million.

This effectively means that a single person who owns their own home can pass up to £500,000, free of IHT, while married couples and civil partners can pass on up to £1 million, since transfers between spouses and civil partners are tax free.

How can I mitigate my IHT bill?

Looking a little more closely at what might happen to your money and assets when you die, there’s often plenty you can do to reduce the amount of IHT your family may eventually pay. By gifting some of the inheritance money while you’re still around – you also have the reward of seeing the difference your money can make in your lifetime.

Here are four ways that you can mitigate your Inheritance Tax bill and leave more to those you love.

1. Start giving money now

One of the easiest – and most pleasurable – ways to cut your IHT bill is to reduce the value of your estate by giving money or assets away. This reduces your ultimate IHT bill and may save you some tax. Plus, you’ll still be here to see the difference your money can make at first hand. You could help buy a grandchild their first car, pay for a family holiday, or even help out with a deposit on a first home.

How much can I give away?

Each tax year, you can give away up to £3,000 tax free, which is called your annual gifting exemption. You can also make any number of small gifts up to £250 per person,
which is called your small gifts exemption (provided you haven’t made other gifts to the same person). These exemptions apply each tax year. In addition, if your son or daughter is getting married, you can gift them £5,000, you can gift £2,500 to a grandchild or great-grandchild getting married and £1,000 to anybody else.

That’s going to buy a great honeymoon and save some IHT later on.

The other good news is that if you didn’t use your £3,000 gifting exemption in the previous tax year, you can combine two years’ worth and give away £6,000. If your civil partner or spouse does this too, that’s £12,000, but you’ll need to make the gifts before tax year-end on 5 April.

Gifting – the seven year rule

The gifting allowance appears to be the ‘gift that keeps on giving’. You make a gift and reduce the value of your estate for Inheritance Tax purposes simultaneously.

However, if you die before seven years have passed and the gift is above your available IHT exemption it will become chargeable to IHT and tax may be payable. One little bit of good news however, the rate of tax which applies to the gift over the available allowance tapers off after three years, ranging from 40% to 0%. This is called taper relief. But essentially, if you’re considering making a larger gift, get generous sooner rather than later, if you want to avoid the IHT seven year rule.

2. Make gifts from spare income

As a consequence of the proposed changes, making regular gifts from your disposable income may become -more popular for those with higher net incomes. This, in tax-terms, is known as the ‘normal expenditure out of income exemption’. If you’ve got more income than you need to live on, you can gift money on a more regular basis. Lots of families may choose to do this.  You might want to help towards school/ nursery fees, or help out with regular bills or a mortgage repayment.

For this to help mitigate your eventual IHT bill, you need to demonstrate to HMRC that you can afford these payments and still enjoy a comfortable standard of living.

Always keep a record of these gifts – and let your loved ones know where it is or give them a copy. This can really help if the payments are investigated by HMRC, either before or after you die.

3. Make your Will – and keep it up to date

A Will is the surest way to make sure that your money reaches the right people at the right time. Not making a Will – dying ‘intestate’ – means frustration, delay and sometimes heated family disputes – which you won’t be around to referee.

Most couples who are either married or in a civil partnership can leave everything to each other without paying IHT. But if you’ve got a long-term partner who isn’t a spouse or civil partner, they could lose out to parents or children if you don’t make a Will.

A Will isn’t a ‘make-it-once-and-forget-it’ exercise. Lives move on, partners change and new relationships, even whole new families, come along. If you’ve divorced, or separated, you may want to change your Will so that your new partner can inherit. Or, if you remarry, you may want to make your new stepchildren beneficiaries too.

While you’re at it, you should check that you’ve nominated the right beneficiary on any pensions you may hold. Otherwise, your pensions may not end up where you intended.

4. Sort out life assurance – and write it in trust

You can’t always bring an IHT bill down to zero. After all, you don’t know exactly how your later life will pan out or how much money you might need yourself.

One IHT-friendly option is to take out a life-assurance policy where the sum assured covers your predicted IHT bill (you can use our IHT calculator to help.) That way, your family can use these funds to cover the tax bill.
For this to work, however, you need to write the policy in trust. That way, the pay-out falls outside your estate for IHT purposes. The premiums you pay into the policy are considered as a lifetime gift and may be covered under the ‘expenditure out of normal income’ rule, or your annual gifting exemption.

We strongly recommend speaking with a financial adviser first before you take out any policies, so that you consider all your options for de-risking your IHT liability before committing to either life assurance policies, or trusts.  

Leaving the legacy you want to

The further ahead you plan your IHT mitigation strategy, the larger your legacy could be. Talking about your own death isn’t the easiest conversation for anybody to have, but
starting the conversation, and coming up with a plan, will reassure you that, when you go, your family will be financially secure.

If you'd like to talk about estate planning with us do, get in touch today.

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The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances.

Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place. Wills and Trusts are not regulated by the Financial Conduct Authority.

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