How To Avoid Inheritance Tax

In the tax year 2022 to 2023, 4.62% of UK deaths resulted in an Inheritance Tax (IHT) charge. So the vast majority of people don't have to worry about it. But that doesn't stop them. Although not many people pay it, the tax raises a fair amount of money. In the 2022/23 the government got £6.7 billion from the tax.

There’s normally no Inheritance Tax to pay if either:

• the value of your estate is below the £325,000 threshold

• you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club

But many people who have spent their lives saving, partly in order to help their children and loved ones, do worry about IHT and for those, here are some ideas of how to minimise the tax they will pay.

Giving Your Home To The Kids

If someone dies and their estate is worth more than the basic Inheritance Tax threshold, their estate may qualify for the residence nil rate band (RNRB) before any Inheritance Tax is due. You can find more information about the residence nil rate band here.

The Residence Nil Rate Band (RNRB) is an additional allowance introduced to help homeowners pass on their main residence to direct descendants without incurring significant Inheritance Tax.

Everyone already has a Nil Rate Band (NRB) — currently £325,000 (frozen until at least April 2028).

The Residence Nil Rate Band (RNRB) is in addition to that, currently worth up to £175,000 per person (also frozen until 2028).

The deceased must have left their residence to direct descendants, which include children, grandchildren, or even great-grandchildren.

If one spouse dies and doesn’t use their full RNRB (for example, if they die before the rules came in or leave everything to their spouse), the unused portion can be transferred to the surviving spouse, just like the main Nil Rate Band.

So when the second spouse dies, the estate could benefit from:

2 × £325,000 (NRB) = £650,000

2 × £175,000 (RNRB) = £350,000

Total = £1 million tax-free.

Giving Away The Home - But Still Want To Live In It

If you give away your home but stay living there, it’s known as a gift with reservation. This means it’s treated as still being in your estate for IHT purposes. To avoid this, you need to pay rent at the market rate to the person to whom you gave your home. They could then end up paying tac on the income- so it's not without its problems.

Get Insurance to pay the tax

Whole of life policies, pay out on death, providing premiums have been maintained. The policy is often written in trust, which may mean that any payout is outside your estate and is therefore available to settle a future IHT bill.

The concept of whole of life insurance is thought to have first emerged in the early 1700s, when the Amicable Society for a Perpetual Assurance Office, founded by William Talbot and Thomas Allen, started to insure members for the duration of their lives.

Unlike term life insurance, it does not have an end date and guarantees a lump-sum payment to the policyholder’s beneficiaries on death.

It may also be free of charge, if your estate and life insurance policy are relatively straight forward, according to MoneySupermarket.com

Get Married

"Darling, let's get married - the tax advantages are great." - It may not sound romantic - but it is true.

Married couples and civil partners can take advantage of the spouse exemption which allows everything to pass between them IHT-free. It’s not the stuff of rom-coms but it might stop you having to sell the house to settle an IHT liability.

Gifts

Of course just giving away your money as a way of reducing inheritance tax is not more a useful tip than by saying you can reduce your income tax by telling your employer that you would like a pay cut. But this route is something mroe subtle than it first appears.

If you have more income than you need, you may be able to give regular gifts out of your surplus income.

The broad requirements are that while there’s no limit on how much you can give:

• The gifts must not affect your standard of living

• It has to be a regular gift

• It comes from income rather than capital

Saga say that a freedom of information request from Quilter Cheviot found that just 480 estates – less than 2% of those liable for IHT – had taken advantage of this exemption in the 2021/22 tax year (the most recent year for which figures are available).

It may be that few people know of the IHT exemption and therefore are not using it.

As always - take advice before you do anything

Giving To Charity Can Benefit Your Family

There’s no IHT to worry about with gifts to charities. But giving to charity, can also benefit your family. That's because if you leave at least 10% of your net estate to charity in your will, it’ll reduce the IHT rate from 40% to 36%.

Trusts

A trust can give you more control over how your money is distributed. Discretionary trusts are the most common although there are lots of diofferent types and it gets co mplexand legal, very quickly. Be aware that the rules around inheritance tax and trusts are complicated, and it might cost you more by opening a trust, so again, it's very important to take advice as with all aspects of finance, we touch upon.

The consumer organisation Which? offer some rules of thumb, which provides a great overview, which says that:

1. Pay 20% IHT when setting the trust up

2. Pay up to 6% IHT each 10 year anniversary

3. IHT will need to be paid again when the trust is closed, or if assets are removed. Tax is based on the most recent 10-year anniversary valuation, up to 6%, charged on a pro-rata basis.

In addition to the inheritance tax charge when setting up the trust, the trustees will likely charge a fee for managing the trust, and there are other legal costs to setting one up.

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