Inheritance Tax (IHT) is a significant concern for many people, as it can substantially diminish the estate you pass on to your loved ones. With the amount of IHT collected on the rise, more individuals are looking for ways to reduce the impact of this tax. Fortunately, with careful planning and the right strategies, you can minimize your IHT bill and ensure more of your wealth is preserved for future generations.
In this post, we’ll explore four key methods to reduce your Inheritance Tax bill, including gifting, using available allowances, making tax-friendly investments, and utilizing trusts.
1. Gifting to Reduce Your IHT Bill
One effective way to reduce the value of your estate and lower your Inheritance Tax liability is by making regular gifts. These gifts, if made from surplus income and in accordance with the rules, may be exempt from IHT.
Regular Gifts from Surplus Income
Gifts made from your surplus income, as long as they don’t affect your standard of living, can be exempt from IHT. However, it’s important to keep track of these gifts and maintain records of the amounts you give. These gifts should be regular and made with clear intention to avoid any misunderstandings. A good financial advisor can assist you in calculating how much you can afford to give without affecting your future financial security.
Annual Gift Allowance
Each individual can gift up to £3,000 each year without triggering IHT. If you didn’t use this allowance in the previous year, it can be carried over, meaning you could give £6,000 in a tax year.
Small Gifts Exemption
You can also make small gifts of up to £250 per person annually, as long as the recipients are different individuals. This provides a straightforward way to reduce your estate without worrying about IHT.
Wedding and Civil Partnership Gifts
Gifts given for weddings or civil partnerships can also be exempt from IHT. Parents can gift up to £5,000, grandparents up to £2,500, and others can gift £1,000 without any tax implications. These gifts can help your loved ones at significant life events without increasing your estate’s value.
2. Maximise Available Allowances
Understanding and making full use of available IHT allowances is crucial. These allowances can change over time, so it’s important to stay informed.
Nil-Rate Band
The Nil-Rate Band (NRB) allows for the first £325,000 of your estate to be exempt from IHT. This threshold has been frozen until at least 2030, meaning it’s important to consider the effects of inflation and rising asset values in your estate planning.
Transfers between spouses are tax-free, so if one spouse leaves everything to the other, the full £325,000 remains intact and can be used by the surviving spouse. This means that they could inherit a combined Nil-Rate Band of up to £650,000.
Residence Nil-Rate Band
If you’re passing on your home to direct descendants, an additional allowance of up to £175,000 is available, which could increase the tax-free threshold to £500,000 per individual or £1 million for a couple. However, this allowance begins to taper off for estates worth more than £2 million. For estates exceeding this amount, the Residence Nil-Rate Band is reduced by £1 for every £2 over the £2 million threshold.
Charitable Donations
Donations to charity are exempt from IHT, making them an excellent way to reduce your estate’s tax burden. Additionally, if you donate more than 10% of your estate to charity, your estate may benefit from a reduced IHT rate of 36%, which can lower the overall tax liability.
3. Tax-Efficient Investments
Investing in certain assets can also help reduce your IHT bill, although these investments tend to come with higher risks. It’s essential to consult with a financial advisor if you’re considering these options.
Agricultural and Business Relief
If you own agricultural or business assets, you may be eligible for relief from IHT. Agricultural assets can receive up to 100% relief after being held for two years. Business owners may also qualify for business relief, which applies to shares in trading companies (not investment companies). These types of assets can reduce the value of your estate and lower your IHT liability.
AIM-listed Shares
Shares in companies listed on the Alternative Investment Market (AIM) in the UK can qualify for 100% IHT relief, as long as they are held for two years before death. However, this relief will decrease to 50% after April 2026. AIM shares can be volatile, so this type of investment carries higher risk and should be approached with caution.
Pensions
Pensions are typically exempt from IHT when passed on. As of April 2027, however, pensions will form part of your estate for IHT purposes. Until then, pension funds can be passed on without triggering a tax bill, so it’s worth nominating a beneficiary for your pension to ensure it goes to the right person.
4. Using Trusts to Minimise IHT
Trusts are a powerful tool in estate planning and can be used to reduce IHT by removing assets from your estate. When you place assets in a trust, they are no longer considered part of your estate, although they can take up to seven years to fully exit.
There are various types of trusts, each with its own legal and tax implications. A financial advisor can help you select the right type of trust based on your circumstances and goals.
5. The Simpler Option: Spend It!
An enjoyable and simple way to reduce the size of your estate is to spend some of your wealth during your lifetime. Many people are reluctant to spend their savings, particularly during retirement, for fear of running out of money. However, with a solid financial plan in place, you can calculate how much you can afford to spend without compromising your financial security.
Spending on experiences with loved ones rather than leaving large sums behind can create valuable memories and reduce the overall value of your estate, lowering the amount subject to IHT.
Conclusion
Reducing your Inheritance Tax bill requires thoughtful planning and the use of strategies like gifting, maximising allowances, making tax-efficient investments, and utilizing trusts. The right approach depends on your specific circumstances, including your financial goals, health, and risk tolerance. Working with a financial advisor can ensure that you take advantage of these strategies and reduce the tax burden on your estate, leaving more for your loved ones.