Often dubbed the “most hated tax” in the media, Inheritance Tax (IHT) is a tax on your estate when you pass away, which could reduce how much you leave behind for family and friends. If your estate is worth more than £2 million, the potential IHT bill might be higher than you expect. Read on to find out why.
Frozen thresholds mean the number of estates liable for IHT is on the rise. Indeed, according to a November 2024 BBC report, around 4% of estates were liable for IHT in 2024 and it’s expected to rise to 7% by 2032.
HMRC statistics show £6.3 billion was collected through IHT receipts between April 2024 and December 2024 – £0.6 billion higher than the same period in 2023.
As the standard IHT rate is 40%, it could significantly reduce the value of your estate if it’s liable. So, it’s important to understand if your estate exceeds IHT thresholds.
The residence nil-rate band is reduced if your estate is worth more than £2 million
Usually, when passing on assets to loved ones, you can make use of two key thresholds.
- The nil-rate band, which is £325,000 in 2024/25 and frozen until April 2030. If the entire value of your estate falls below this threshold, no IHT will be due.
- The residence nil-rate band could increase how much you’re able to pass on before IHT is due if you leave your main home to your children or grandchildren. In 2024/25, the residence nil-rate band is £175,000 and is also frozen until April 2030.
You can leave assets to your spouse or civil partner without them being liable for IHT, and you may also pass on unused IHT allowances. So, if you’re planning as a couple, you could leave up to £1 million to loved ones before your estate may be liable for IHT.
However, a little-known rule could mean the amount you’re able to pass on before IHT is due is lower.
If the value of your estate is more than £2 million, a taper reduces the residence nil-rate band. For every £2 that the value of your estate exceeds this threshold, the residence nil-rate band will reduce by £1. So, if your estate is worth more than £2.35 million, it will not benefit from the residence nil-rate band.
As a result, your loved ones could face a higher bill than you expect.
5 proactive steps you could take to reduce a potential Inheritance Tax bill
The good news is there are often steps you can take to reduce a potential IHT bill if you’re proactive. So, making IHT part of your wider estate plan could mean you’re able to pass on more to loved ones.
Here are five steps you may want to take if you’re concerned about IHT.
1. Write a will
Writing a will is a way to ensure your assets are passed on in a way that aligns with your wishes. It may also be used to pass on your assets tax-efficiently.
For example, you might state that certain assets are to go to your spouse or civil partner, so they aren’t considered for IHT purposes.
While you can write your will yourself, seeking legal support may be useful. A solicitor could minimise the risk of mistakes occurring and ensure your will clearly sets out your wishes.
As your circumstances and wishes can change, it’s often a good idea to review your will following major life events or every five years.
2. Gift assets during your lifetime
One way to cut an IHT bill is to reduce the value of your estate by passing on wealth during your lifetime.
This option could have other benefits too. You’ll be able to see the effect your gifts have and you might be able to offer financial support when your loved ones would benefit from it most. For instance, a gift to your child when they’re struggling to get on the property ladder could be more useful to them than an inheritance later in life.
However, it’s important to note that not all gifts will be considered immediately outside of your estate for IHT purposes. Usually, gifts will be considered for up to seven years. These are known as “potentially exempt transfers”.
Some gifts will be immediately outside of your estate when calculating IHT, including:
- Up to £3,000 each tax year known as the “annual exemption”
- Small gifts of up to £250 to each individual, so long as they have not benefitted from your annual exemption
- Wedding gifts of up to £1,000, rising to £5,000 for your child or £2,500 for grandchild
- Regular gifts from your surplus income that are part of your normal expenditure and do not affect your usual standard of living.
It’s often a good idea to keep a record of gifts, particularly if you plan to gift from your surplus income as HMRC may check to see if the gifts are part of a pattern.
A financial plan could assess the effect of passing on assets during your lifetime and help you understand how gifting might affect your financial security later in life.
3. Place assets in a trust
You may take assets outside of your estate by placing them in a trust and potentially reduce the IHT bill your estate pays as a result.
You can specify who you’d like to benefit from the assets held in a trust, known as the “beneficiary”, and who will manage the trust on their behalf, known as the “trustee”.
Trusts can be complex and once you’ve transferred assets you may not be able to reverse the decision. As a result, taking professional advice could help you assess what’s right for you.
As a financial planner, we could help you understand the effects of placing assets in a trust and how you might do so in a way that aligns with your wishes. A solicitor could also offer support in writing a trust deed, which would establish the trust and set out any rules or conditions you may have.
4. Leave 10% of your estate to charity
If you leave at least 10% of your entire estate to charity in your will, the IHT rate your estate pays may fall from 40% to 36%.
In some cases, leaving a portion of your estate to charity could mean passing on more wealth to your loved ones while supporting a good cause.
5. Take out life insurance
Life insurance won’t reduce an IHT bill, but it could provide your loved ones with a way to pay it.
If you took out whole of life insurance, it would pay out a lump sum on your death to your beneficiary, which they may then use to pay an IHT bill. It’s an approach that could mean you’re able to pass on your estate intact and reduce stress for your loved ones.
You may need to calculate the potential IHT bill to ensure the payout would cover the entire amount. You’ll also need to pay regular premiums to maintain the cover.
It’s also important that the life insurance is placed in trust, otherwise, the payout could be included in your estate when calculating IHT and lead to a larger bill.
Get in touch to talk about your estate’s potential Inheritance Tax liability
There are often other steps you might take to reduce your estate’s IHT liability too. If you’d like to discuss your estate and how you might pass on wealth to your loved ones efficiently, please get in touch to arrange a meeting.
Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.
