In recent years, Inheritance Tax (IHT) has become an issue for more and more Brits, as frozen thresholds see an increasing number of estates fall foul of the tax.

Money Week recently revealed that the Treasury collected £3.2 billion from IHT in the three months between April and August 2023, a £300 million rise from the same period the previous year.

One potential reason for this rise is the frozen nil-rate band – the threshold on the value of your estate above which it becomes liable for IHT, as well as wage growth and rising house prices over the last decade. 

Often purported as the UK’s “most hated tax”, continue reading to discover four practical ways to protect your loved ones from IHT when they eventually inherit your estate.

1. Make use of HMRC’s gifting exemptions

One practical way to limit an IHT liability is to reduce the overall value of your estate. You might do this, while simultaneously supporting your loved ones, by taking advantage of HMRC’s tax-free gifting exemptions.

In the 2023/24 tax year, you can gift up to £3,000 each year thanks to the annual exemption, with these gifts falling outside your estate for IHT purposes. Moreover, you can carry this exemption forward for one year, allowing you to gift a total of £6,000 if you have not used the previous year’s exemption.

This £3,000 limit is also an individual exemption, so if you’re part of a couple, you could gift up to £6,000 between you in a single tax year. 

You can also make unlimited small gifts – worth up to £250 – in a single tax year. These small gifts aren’t subject to IHT, and don’t form part of your £3,000 exemption. 

What’s more, a gift to a couple for their wedding or civil partnership will also fall outside of your estate, as long as you make the gift before the wedding takes place. The amounts you can give tax-efficiently are as follows:

• Up to £5,000 to your child
• Up to £2,500 to your grandchild or great-grandchild
• Up to £1,000 to another family member or a friend. 

IHT rules also allow for a “normal expenditure out of income” exemption, meaning that regular gifts from your income, such as savings for a child, may be free from IHT. 

To qualify, the gift must:

• Come from your normal income
• Be part of your normal outgoings
• Not detrimentally affect your standard of living. 

It’s important to keep a record of these gifts from income so that you can prove to HMRC that the above criteria have been met.

2. Give while living and make the most of “potentially exempt transfers”

Leaving money to loved ones in your will is the traditional way to pass on wealth. An increasing trend, though, is known as “giving while living”. 

Research from Aviva reveals that more than half of over-55s want to give financial support through gifting during their lifetime.

Not only do these gifts reduce the overall value of your estate, but you’ll still be around to witness the good your money can do. You might also find that you’re providing a cash boost to loved ones at the best possible time – when they’re starting a family, say, or looking to buy a first home.

You can give as many gifts as you like during your lifetime, and they will only become liable for IHT if you die within seven years of giving the gift. For this reason, they are known as “potentially exempt transfers” (PETs). 

The earlier in life you start making gifts, the greater your chance of surviving beyond seven years, and seeing those gifts fall outside the value of your estate for IHT calculation purposes. 

3. Consider leaving a legacy to a charity

Donating to a charity can reduce the value of your estate while supporting a cause close to your heart.

This altruistic act not only means that your money will do some good after you pass away, but also it allows you to lessen a potential IHT liability on your estate. This is because anything you leave to charity in your will is exempt from IHT. 

Additionally, if you leave more than 10% of your taxable assets to a charity, you could benefit from a reduced rate on the IHT payable on any part of your estate above the nil-rate band. In these instances, the usual IHT rate of 40% drops to just 36%. 

4. Use your pension 

Pensions generally fall outside of your estate, which can make them an effective tool to help manage a potential IHT liability.

As such, it may be wise to fund your retirement from savings and investments, leaving your pensions until last, if you can afford to. 

This could help you reduce the value of your savings, investments, and properties, ensuring they fall within the nil-rate bands. It also means you have the potential to pass on unused pension pots, tax-free, in some circumstances.

Pension beneficiaries – named via an “expression of wish” form with your pension provider – could inherit your pension fund IHT-free in the event of your death before age 75. If you’re over 75 when you pass away, your beneficiaries can still inherit your pension fund, but they’ll likely need to pay Income Tax at their marginal rate.

Get in touch

If you’re still concerned about how much Inheritance Tax your loved ones could pay on your estate, then we can help develop strategies to mitigate any potential liability.

Please get in touch and speak to us today to receive expert help from our Chartered Financial Planners.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.