There is often ‘fear driven’ communication around inheritance tax which can leave people paralysed to act. In reality, it’s possible to mitigate inheritance tax impact quite easily so here’s a quick summary of some effective methods to reduce your inheritance tax liability.
First and foremost, every individual has a nil rate band, which is the threshold below which no inheritance tax is payable. For the 2023/24 tax year, this stands at £325,000. On top of this, if you pass on your home to your direct descendants, you can benefit from the residence nil rate band, currently set at £175,000. This means a potential combined threshold of £500,000 per person, or £1million for a couple.
Gifting is a powerful tool in the fight against inheritance tax. Each year, you can give away up to £3,000, which is exempt from inheritance tax. If you didn’t use this allowance last year, it can be carried forward, potentially exempting £6,000 in gifts. Additionally, small gifts up to £250 can be made to any number of people annually.
For weddings, you can gift up to £5,000 to a child, £2,500 to a grandchild, and £1,000 to others, all free from inheritance tax. Gifts which are part of your normal expenditure out of income, such as regular payments to a child or grandchild, can also be exempt, provided they don’t affect your standard of living. These can be substantial of course if your income exceeds your expenditure.
Larger gifts (than the above) fall under what is called a Potentially Exempt Transfer (PET). If you survive seven years after making a gift, it becomes completely exempt from inheritance tax. Should you pass away within this period, a tapered relief applies, reducing the tax rate.
Trusts can offer significant inheritance tax planning benefits. A discretionary trust allows you to move assets outside of your estate to reduce your taxable estate and to control how your assets are distributed later and can be protected from creditors or a beneficiary’s divorce.
A bare trust allows you to gift to a minor who will only receive the money at age 18. It is treated as the beneficiary’s asset, which can sometimes be more tax-efficient, especially for younger beneficiaries.
If you own a business or agricultural property or invest into investment assets which qualify for business relief, you might be eligible for significant inheritance tax reliefs. Business relief can offer up to 100% relief on the value of business assets, while agricultural relief provides up to 100% relief on qualifying agricultural property.
Donations to registered charities are exempt from inheritance tax, and if you leave 10% or more of your estate to charity, the Inheritance Tax rate on the remaining estate can be reduced from 40% to 36%. This not only supports a cause you care about, it also provides a tax-efficient way to reduce the burden on your estate.
You can insure yourself for the tax payable and leave the death benefit in trust which will pass directly to beneficiaries free of tax and allow them to pay their inheritance tax bill and release the estate. This can be particularly useful if your estate includes illiquid assets like property.
Pensions are generally outside your estate for inheritance tax purposes. Keeping funds within a pension scheme can be a strategic way to pass on wealth free from inheritance tax, offering both tax efficiency and financial security for your beneficiaries.
Transfers between spouses or civil partners are inheritance tax free. This can be used to defer inheritance tax until the death of the second spouse or partner, giving more time to plan and potentially reduce the tax burden further.
Estate planning isn’t a one-off task. Regular reviews with an independent financial advisor are essential in ensuring your strategy remains effective and compliant with current laws. Legislation and personal circumstances change, and your estate plan should evolve accordingly.
By understanding and using the available exemptions and reliefs, you can significantly reduce the inheritance tax burden, if not mitigate completely, ensuring your loved ones receive the maximum benefit from your estate.
- Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. For a free guide to inheritance tax, or if you have a question on money, call Darren McKeever on 028 6863 2692.
