How to mitigate your Inheritance Tax bill

15 March 2024

4 minutes

At a glance

• Nobody wants a large Inheritance Tax bill to be the biggest legacy they leave their family.
• Gifting, passing on pensions and life assurance are several options for mitigating your IHT liability.
• Starting your inheritance planning early and taking financial advice can have a direct impact on your family’s financial wellbeing after you’re gone.

Nobody likes talking about death, and many of us aren’t that keen about talking money either. So it’s not surprising that many of us put estate planning, and IHT strategy, on a back burner.

However, while we might not enjoy talking death and taxes, one thing’s for certain. Nobody wants to pay HMRC any more than they have to.

But when you start thinking about what will happen to your money when you die, there’s often plenty you can do to reduce the amount of IHT your family may eventually pay. By gifting some of the inheritance money while you’re still around – making a ‘living inheritance’, as it’s known – you also have the reward of seeing the difference your money can make in your lifetime.

What is Inheritance Tax and how is it charged?

Inheritance Tax is currently charged at 40% of the value of your estate, over £325,000. But you can also claim an extra allowance, known as the Residence Nil Rate Band (RNRB), of up to £175,000 if you’re passing your residential property on to a direct descendant. A direct descendant is a child, grandchild or lineal descendant of the person who has died. This is so long as your total estate is less than £2 million.

This effectively means that a single person who owns their own home can pass on £500,000, free of IHT, while married couples and civil partners can pass on up to £1 million as transfers between spouses and civil partners are tax free.

Here are five ways that you can mitigate your Inheritance Tax bill and leave more to those you love.

1. Start giving money away now

One of the easiest – and most pleasurable – ways to mitigate an IHT bill is to reduce the value of your estate by giving money or assets away. This reduces your ultimate IHT bill and saves you some tax. Plus, you’ll still be here to see the difference your money can make to your family. You could buy a grandchild their first car, pay for a family holiday, or even help out with a deposit on a first home.

How much can I give away?

Each tax year, you can give away up to £3,000 tax free, as well as make any number of small gifts up to £250 per person (provided you haven’t used another allowance on the same person). This is your annual gifting allowance. In addition, if your son or daughter is getting married, you can gift them £5,000, you can gift £2,500 to a grandchild or great-grandchild getting married and £1,000 to anybody else.

That’s going to buy a great honeymoon and save some IHT later on.

The other good news is that if you didn’t use your £3,000 gifting allowance in the previous tax year, you can combine two years’ worth, and give away £6,000. If your civil partner or spouse does this too, that’s £12,000, but you’ll need to make the gifts before tax year-end on 5 April.

Gifting – the ‘seven year hitch’

The gifting allowance appears to be the ‘gift that keeps on giving’. You make a gift and reduce the value of your estate for IHT purposes simultaneously.

If you die before seven years have passed, the gift will still be part of your estate, and IHT may be payable. One little bit of good news however, the rate at which it will be charged tapers off over time from 40% to 0%. This is called taper relief.

2. Make gifts from spare income

If you’ve got more income than you need to live on, you can also gift money on a more regular basis. Lots of families are choosing to do this, particularly as the cost-of-living crisis has squeezed households hard. You might want to help out with school or nursery fees, regular bills or a mortgage repayment.

For this to help mitigate your eventual IHT bill, you need to demonstrate to HMRC that you can afford these payments and still enjoy a comfortable standard of living.

Always keep a record of these gifts – and let your loved ones know where it is or give them a copy. This can really help if the payments are investigated by HMRC, either before or after you die.

3. Save more into your pension

Pensions aren’t just a great way to save for retirement. They can also be a very useful, tax-efficient planning tool.

Since most pensions sit outside your estate, they’re not counted when the IHT bill is being calculated. You can pass them on to your beneficiaries, who will pay some income tax on the money when they withdraw it, but not the IHT rate of 40%.

If you die before you’re 75, your pension can be paid as a lump sum or regular income to any beneficiary, free from tax.

If you die after age 75, your beneficiaries will only need to pay tax at their marginal rate on withdrawals. That could save them 20% if they’re basic rate taxpayers.

So if you’re worried about leaving your family with a large IHT bill, the more money you can pay into your pension, the better. You can still access it if you need to while you’re alive. But if you don’t touch it, you can pass it on to your loved ones in a tax-efficient way.

4. Make a Will – and keep reviewing it

A Will is the surest way to make sure that your money reaches the right people in the right amount at the right time. Not making a Will means frustration, delay and sometimes bitter family disputes – which you won’t be around to sort out.

Most couples who are either married or in a civil partnership can leave everything to each other without paying IHT. But if you’ve got a long-term partner who isn’t a spouse or civil partner, they could lose out to parents or children if you don’t make a Will.

A Will isn’t a ‘make-it-once-and-forget-it’ exercise. Our lives move on, partners change and new relationships, even whole new families, come along. If you’ve divorced, or separated, you may want to change your Will so that your new partner can inherit. Or, if you remarry, you may want to make your new stepchildren beneficiaries too.

While you’re at it, you should check that you’ve nominated the right beneficiary on any pensions you may hold. Otherwise, your pensions may not end up where you intended.

5. Sort out life assurance – and write it in trust

You can’t always bring an IHT bill down to zero. After all, you don’t know exactly how your later life will pan out or how much money you might need yourself.

One IHT-friendly option is to take out a life-assurance policy where the sum assured covers your predicted IHT bill (you can use our IHT calculator to help.) That way, your family can use these funds to cover the tax bill.

For this to work, however, you need to write the policy in trust. That way, the pay-out falls outside your estate for IHT purposes – which means that the money is readily available for your executors to settle your estate. It’s a good idea to take financial advice, if you’re thinking of doing this.

Leaving the legacy you want to

The further ahead you plan your IHT mitigation strategy, the more powerful your legacy will be. Talking about your own death isn’t the easiest conversation for anybody to have but having the conversation, and coming up with a plan will reassure you that, when you go, your family will be financially secure.

The end of the tax year is a good time to talk about estate planning with us. Get in touch today.

The value of an investment with us will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances.

Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place. Wills and Trusts are not regulated by the Financial Conduct Authority.

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