Managing inheritance tax (IHT)

Like many other taxes, IHT allowances have been frozen. This sounds generous of the Chancellor at a time when the UK Government is strapped for cash but it actually means that we are paying more. Data from HMRC has revealed that IHT collected between April 2022 and February 2023 totalled £6.4bn, which is £900m higher than for the same period last year.

The increase is actually due to the frozen tax-free allowance for IHT (also known as the nil-rate band) coupled with the rocketing rise in house prices.

It is now estimated that 10,000 more families could end up paying IHT and the Treasury could receive nearly £8 billion per year over the next few years.

How can you reduce your IHT bill?

When you die, your estate is valued, and this value is subject to IHT. Generally, any excess over the nil-rate band (currently £325,000) is chargeable to IHT at 40%. But there are ways to reduce your IHT bill.

1. Give it away

The easiest way to pass your wealth onto your loved ones without paying tax is simply to give it to them.

• You can give up to £3,000 to loved ones each tax year without it becoming liable for IHT. If you did not use the allowance last year, you can combine it and pass on £6,000 in the current tax year.
• Wedding gifts of £5,000 to children are also protected from IHT; grandchildren can have up to £2,500.

If you die within seven years of making a larger gift, IHT is likely to be payable. There is a sliding scale. If you pass away within three to four years after making the gift and IHT is payable, the IHT rate lowers to 32%. If you pass away within six to seven years the IHT rate reduces further to 8%.

There is another way to give. Donate at least 10% of your estate to charity and get a 4% discount on the IHT rate for the rest of your estate, lowering it from 40% to 36%.

2. Put it in a pension

Your pension, depending on the type of pension plan you hold, if it is kept invested could be used to pass on wealth as it is usually excluded from your estate for IHT purposes. If you nominate beneficiaries for your pension, IHT will not normally be payable on the value of the pension, should you pass away before you draw it.

However, if you die after the age of 75, your beneficiaries will need to pay income tax on the money they take out of your pension.

3. Invest it (carefully)

Making the right kind of investments might help you avoid IHT. An individual savings account (ISA) cannot help. ISAs are exempt from income tax and capital gains tax, but they form part of your estate for IHT.

There could be other solutions such as with Alternative Investment Market (AIM) holdings.

The companies listed on AIM tend to be smaller and more highly speculative in nature, in part due to AIM’s relaxed regulations and listing requirements. However, Investing in AIM companies tends to be high risk investing and is not a route most people should consider. You should seek independent financial advice before considering investing in this market, remembering that, when investing, your capital is at risk and you could lose some or all of your investment.

4. Put it in trust

Setting up a trust to hold your assets could keep the value of the assets out of your estate and therefore out of the taxman’s reach.  But the position has become more complicated in recent years and Trusts may not always be suitable.

They sometimes still have their uses. The trustee can control the assets, rather than them being passed onto the beneficiaries right away. This might help if your beneficiaries are not known for financial prudence or are young children. You should seek independent financial/legal advice before establishing a trust.

5. Insure it

You can take out a whole of life insurance policy large enough to mitigate some or all of your IHT liability. You may need to regularly review the level of cover if your estate increases in value as the original sum assured may not cover the whole IHT liability.

Alternatively, you may choose a plan where the cover increases with inflation. Whichever option is chosen, have it written in trust. Your beneficiaries then will not have to struggle with a huge IHT bill when you die, but while you are alive you will be paying monthly premiums.

6. Get some help

Expert advice can be vital to help work out the total value of an estate, calculate how much IHT is likely to charged and understand what options are available to manage that tax bill. Advice on writing up a will to be tax efficient is also essential.

The information in this blog provides only an overview of HMRC guidance and legislation in force at the date of publication and no action should be taken without consulting the detailed HMRC guidance and legislation or seeking professional advice.  Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this blog can be accepted by the firm.