How to Minimise Inheritance Tax: A Comprehensive Guide
Written by Claire Thompson | Wills, Trusts, Tax and Probate Team | 30 July 2024
Inheritance Tax (IHT) can have a significant impact on the amount that your beneficiaries receive from your estate. Understanding how it works and implementing strategies to minimise its impact can help ensure that your loved ones benefit as much as possible from your estate.
In this blog post, we’ll explore the intricacies of inheritance tax, the latest trends, and outline several effective ways to reduce the amount payable.
Understanding Inheritance Tax
Inheritance Tax is a tax value of an estate (the property, money, and possessions) when a person dies.
In some circumstances it can include a tax on gifts made by the person who has died and assets held on trust which they benefit from. In the UK, inheritance tax is usually charged at 40% and you have a nil-rate band, known as the inheritance tax allowance, which means that part of your estate passes free from inheritance tax.
The nil-rate band is currently £325,000 (and has been since 2009). This means that the inheritance tax would be calculated as follows:
Case Study 1:
Laura owns £500,000 of assets. She has not made any gifts in the last 7 years of her life. She has never been married and when she dies she leaves her estate equally between her niece and nephew The first £325,000 of her estate would pass free from inheritance tax and use her inheritance tax allowance. The remaining £175,000 would be taxed at 40% creating an inheritance tax liability of £70,000.
There is an additional allowance which can be claimed if a deceased is leaving residential property that they have lived in that passes immediately on death to linear descendants. This is called the residential nil rate band and is currently £175,000. However, the residential nil rate band reduces by £1 for every £2 that an estate is over £2,000,000.
If we change the fact in our case study we can see how the residential nil rate band works.
Patrick owes £500,000 of assets including his home which is valued at £200,000. He has not made any gifts in the last 7 years of his life. He has never been married and when he dies he leaves his estate equally between his son and daughter. This time the first £175,000 of property passes free from inheritance tax (the residential nil rate band). This leaves £325,000 worth of assets. (Patrick’s cash and £25,000 of property) this is all covered by the inheritance tax allowance (£325,000 which can be set against any type of asset). Patrick estate therefore passes free from inheritance tax.
In certain circumstances the residential nil rate band can still be claimed if you have sold your property or downsized to a less expensive property.
The latest figures from HMRC show that inheritance tax receipts have risen by 7.2% since last year, mainly due to the nil rate band staying the same whilst asset values increase, underscoring the importance of strategic planning to minimise your tax burden.
Key Exemptions and Reliefs
Knowing about key exemptions and reliefs can help you reduce the inheritance tax on your estate. These options are designed to make the tax burden lighter and keep more of your wealth for your loved ones. By using these exemptions, like the spouse or civil partner exemption, charity donations, and various gift allowances, you can lower the taxable value of your estate. Also, special reliefs for businesses and farms can give big inheritance tax breaks, making them important to consider when planning your estate. Understanding these options is an important part of managing inheritance tax effectively.
Spouse or Civil Partner Exemption: Transfers between spouses or civil partners are exempt from IHT. This can be a useful way to defer the tax until the surviving partner passes away. If your spouse or civil partner has died before you and has not used their inheritance tax allowances then your estate can claim the unused allowances. This applies to both the inheritance tax allowance and the residential nil rate band (but remember that to claim the residential nil rate band your estate still needs to meet the necessary criteria).
Charity Donations: Any part of your estate left to a UK registered charity is exempt from IHT. Additionally, if you leave at least 10% of your net estate to charity, the IHT rate on the rest of the estate is reduced to 36%.
Annual Gift Allowance: You can give away up to £3,000 each year without it being added to the value of your estate. This is known as your annual exemption. If you did not use this allowance last year it can be carried forward for one year.
Small Gifts Allowance: You can give away up to £250 to as many individuals as you want each year, provided the recipient has not benefited from another allowance.
Wedding Gifts: Parents can give a wedding or civil partnership gift of up to £5,000, grandparents can give up to £2,500, and anyone else can give up to £1,000.
Business and Agricultural Reliefs: If your estate includes a business or related assets, additional reliefs may apply at rates of either 50% or 100%. Likewise, certain agricultural properties, such as land used for rearing animals or growing crops, can pass free of IHT, provided specific criteria are met.
Strategies to Minimise Inheritance Tax
Managing your estate in order to reduce inheritance tax that you need to pay is crucial to make sure your beneficiaries get the most out of your assets. By using available tax reliefs and planning carefully, families can ensure their loved ones pay the least amount of tax and benefit fully from their inheritance. Here are some proven strategies to help reduce the impact of inheritance tax on your estate.
Use of Trusts: Trusts can be an effective way to manage and protect your assets. Assets placed in certain types of trusts are no longer part of your taxable estate if you survive the creation of the trust by 7 years and other criteria are met. Different types of trusts include:
Bare Trusts: Assets are held in the name of the trustee, but the beneficiary has the right to the assets
Interest in Possession Trusts: The beneficiary has a right to the income generated by the assets
Discretionary Trusts: Trustees have discretion over how the income and capital are distributed among the beneficiaries
Trusts are subject to their own tax regimes so you should take advice before creating a trust.
Gifts and Potentially Exempt Transfers (PETs): Gifts made more than seven years before your death are exempt from IHT as long as the gift is a true gift (this means that you cannot have any benefit from the asset that you have gifted). If you survive the gift by at least three years but less than seven, the inheritance tax due may be reduced on a sliding scale, known as taper relief, but this will depend on the value of the gift.
Life Insurance Policies: Taking out a life insurance policy written in trust can help cover the IHT liability on your estate, ensuring your beneficiaries do not have to sell assets to pay the tax.
Regular Gifts from Surplus Income: If you can demonstrate that regular gifts are made from your surplus income (rather than capital), these gifts are exempt from IHT.
Invest in AIM Shares: Shares listed on the Alternative Investment Market (AIM) can qualify for Business Property Relief if held for at least two years, potentially making them exempt from IHT.
Importance of Creating a Will
Creating a will is essential to ensure your assets are distributed to your chosen beneficiaries. Without a valid will, your estate will be divided according to intestacy rules, which may result in your family not receiving what you intended. Research from The Association of Lifetime Lawyers shows nearly half of UK adults (49%) do not have a will. It’s important to consult a legal professional to help you draft a will. A Will can be extremely efficient in utilising your available allowances to maximum effect and reducing your inheritance tax liability.
Planning Ahead
Effective IHT planning requires careful consideration and often professional advice. By taking steps early, you can significantly reduce the amount of IHT payable and ensure more of your wealth is passed on to your loved ones.
David Cornelius, Partner and Head of the Wills, Trusts, Tax and Probate team at Nash & Co Solicitors, says there are precautionary steps to take if you plan for family members to inherit part, or all of your estate upon your passing. “Unfortunately, death is something we can’t avoid but, unlike the saying, it is possible to avoid a large inheritance tax bill. The key is to plan early. With tax bands still capped at the same level as in 2009 and increasing property prices more families are getting caught. It is highly unlikely that this will change in at least the next few years to it is vital that you get experienced and knowledgeable advice on how you can minimise your inheritance tax liability.”
Here at Nash & Co Solicitors, we specialise in providing crucial advice to help you navigate the complexities of Inheritance Tax. If you have any questions or would like to talk to us about how we can help you, please don’t hesitate to contact us on 01752 827067 or email tax@nash.co.uk.
We’ll do our very best to help you by ensuring that you understand your own position and the options that you have for the future. We can create a bespoke and comprehensive plan that minimises your tax liability and preserves your legacy for future generations.
