How the wealthy avoid Inheritance Tax

Former Labour Chancellor, Roy Jenkins, famously described Inheritance Tax (IHT) as a “voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. While that statement may divide opinion, there is no doubt methods exist in order to mitigate or avoid completely an IHT liability on your estate on death.

Inheritance Tax receipts

 IHT receipts in the UK amounted to over £7bn in the 2022/23 tax year, a staggering increase of over £1bn from the previous tax year which was a previous peak.

Source: Statista

This can be in part attributed to a ‘stealth tax raid’ from the Government, as allowances have been frozen for a number of years, with the chancellor, Jeremy Hunt, also announcing in his Autumn Statement last year that the current IHT thresholds would be frozen until at least April 2028.

Currently, the ‘nil rate band’ allows you to pass on £325,000 of your estate without paying IHT, and an additional ‘residence nil rate band’ of £175,000 is potentially available if your main residence is passed on to direct descendants, giving an IHT allowance of £500,000 per individual or £1m for a married couple/ civil partners. Any value of your estate above these thresholds will typically be subject to IHT at 40% (as noted in more detail below, the latter allowance can be tapered if your estate value exceeds £2m).   

Although an IHT-free threshold of £1m may seem quite generous, the number of people caught in the IHT net has been increasing for several years due to the rapid increase in property prices. In the 18 years running up to January 2023, the average UK house price has almost doubled to just shy of £300,000.

Source: ONS

The residence nil rate band taper

The benefits from inheritance tax planning becomes arguably more impactful for those with estate values of over £2m. For every £2 of your estate value over £2m, the residence nil rate band is reduced by £1. Therefore, the full residence nil rate band is lost if the value of your estate exceeds £2.35m for an individual or £2.7m for a married couple.

What this means in practice is that for a married couple with an estate value of £2.7m the IHT-free allowance can be reduced from £1m down to £650,000, potentially resulting in an additional IHT liability of up to £140,000 (£350,000 @ 40% IHT) due to the loss of this valuable additional allowance.  

What can I do to reduce my Inheritance Tax bill?

Whilst inheritance tax planning can take the form of complex trust arrangements where appropriate, below are some of the key IHT mitigation strategies to consider:

  • Spend more – an often overlooked but simple and effective method of reducing the value of your estate which you will hopefully derive some personal enjoyment from! 
  • Gifting – as shown below, there are certain types of gifts that will fall outside of your estate immediately for IHT purposes. Any gifts that are not immediately tax-exempt or within the annual allowances are treated as potentially exempt transfers (PETs), where you can make gifts of unlimited value which will be exempt from IHT if you survive for a period of seven years. If you don’t survive the gift by seven years, the PET becomes a chargeable consideration and is added to the value of your estate. Specific rules may apply to any gifts made into trusts – please do get in touch if you require information in this regard.

  • Gifts to charity - one key consideration to note is if 10% of your net estate (i.e. the value of your estate above the tax-free allowances) is gifted to charity on death, the rate at which IHT is charged on your taxable estate falls from 40% to 36%. This can significantly reduce any ‘cost’ of a gift to charity and ultimately the amount of your estate that is paid to the taxman. 
  • Contribute to a pension – not only being a useful tool for savings towards retirement, pensions can also be used as an IHT-efficient savings vehicle for passing on wealth to future generations. Assuming a pension is structured in the correct way and written in the form of a trust (most are, but if you are unsure, please do get in touch), it should fall outside of your estate for IHT purposes. Again, if structured in the right way pensions can then be passed down generations whilst potentially being outside of each beneficiary’s estate along the way. 

Recent changes to increase the standard annual allowance for pension contributions to £60,000 from £40,000 combined with the removal of the lifetime allowance have increased the attractiveness of pensions and allow for more to be potentially funnelled into this perhaps overlooked wrapper for estate planning.

  • Set up a life insurance policy – although not mitigating IHT, a life insurance policy can ensure that your beneficiaries have sufficient capital to cover the IHT liability. It is important to consider writing the policy in trust, so it doesn’t form part of your estate and the payment on death is accessible for your beneficiaries prior to any required IHT payment. 
  • Invest in business relief assets – aimed at allowing family businesses to be passed through generations without the need to be sold or broken up to pay an IHT liability, business relief can be received on certain qualifying investments such as unquoted qualifying companies. Whilst there is a 7-year rule for most gifts, business relief assets can be passed on to beneficiaries free of IHT if held for at least two years, and they allow for control of the assets to be retained. These types of assets are however typically very high risk and can be difficult to sell, hence should be approached with caution.

Can I just gift my main residence to my children?

 In simple terms, no. If you continue to live in the property after the gift was made, this will be treated as a ‘gift with reservation of benefit’ and the property would remain in your estate. In order for this strategy to be effective, you would need to pay your children the full market rate rent after gifting the property to them, which can result in additional tax consequences. 

How we can help

A starting point for estate planning is ensuring you have a valid Will in place. This will ensure that your estate is distributed as per your wishes and could reduce the potential IHT liability payable on your death.

Thereafter, whilst mitigating IHT may seem like a key objective, a balance needs to be struck between tax efficiency and retaining sufficient assets to meet your own needs in later life. 

One method in which we can assess the viability of different IHT mitigation methods is through cash flow modelling, whereby your financial future is mapped out so you can see what wealth you need for the life you want, so why not get in touch today to arrange a free no obligation initial discussion  with one of our expert advisers.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

This article is also based upon our understanding of current law, HM Revenue and Custom's practice, tax rates and exemptions which are subject to change.

The Financial Conduct Authority (FCA) does not regulate cash flow planning, estate planning, tax or trust advice.