Inheritance Tax (IHT) is a tax that is charged on property, money and other assets owned by a person following their death. It can be a sensitive subject to discuss but it’s an important conversation to have to ensure your loved ones benefit from the wealth you have amassed.  

Ensuring your will is kept up to date and reflects your current intentions is an important, if morbid, necessity. In addition, how you draft your will and manage your affairs before you die can reduce the amount of IHT that is payable on your death.

IHT is only payable if the entirety of the estate is valued above £325,000 (the nil rate band), which has remained unchanged since 2009. The standard IHT rate is 40% and is charged on the part of your estate that is above this threshold.

The IHT nil rate band increases to £500,000 if your main home is left to your children (including adopted, foster or stepchildren) or grandchildren. Any unused nil rate band can also be effectively added to your surviving partner or civil partner’s estate when they die.

No IHT is owed if the estate is left to a spouse, civil partner, a charity or a community amateur sports club. Similarly, if part of the estate is left to these people that amount is not included in the £325,000 limit.

As part of the IHT legislation there is a provision known as the ‘seven-year rule’. Subject to exceptions, including the ones outlined below, any gifts you make in the seven years prior to you passing away will be considered part of your estate by HMRC.  

There are a number of ways you can legally minimise the amount of tax you are charged on the wealth you leave for your loved ones following your death, we’ve listed five below.  

However, as with all tax planning, this is a guide only and it’s important to seek professional advice.

Make a gift

Gifting up to £3,000 a year tax-free forms part of ‘annual exemption’ before it’s taken into account.

This can be given to an individual or split amongst several people, and also carried forward if unused or leftover for one tax year, which doubles the allowance. You can also give to as many people as you like £250 each tax year so long as you haven’t used another allowance to give funds to the same person.

For your children’s wedding, you can gift up to £5,000, and £2,500 for your grandchildren and great-grandchildren. Anyone else you can gift £1,000 and these amounts are included in your annual giving allowance.

All gifts to charities are tax free, and the IHT charged on your wealth falls from 40% to 36% when you donate 10% of your wealth to a charity organisation or political party on death.                

Regular Income

If you make regular payments, such as monthly, yearly or bi-yearly, to a relative from your regular income, for example, your pension payments or income earned via renting out a property, this money will not be subject to IHT as long as these payments don’t affect your standard of living.

Make sure you keep a record of these payments as it is likely that you will be asked to supply evidence. This method of outcome is covered by the ‘normal expenditure out of income’ and it’s not subject to the seven year rule and there is no cap on the level of gifts you can make.  

Utilise and check your pension

Pension pots are not subject to IHT when you die. If you die before the age of 75, the person who inherits your pension pot can draw on the money as they wish, without paying any income tax either. After 75, the beneficiary will have to pay income tax on any withdrawals at their marginal rate.

It’s worth keeping up-to-date with your pension policy, any funds remaining within defined contribution pensions after you die fall outside the threshold of your estate and are exempt from IHT. If you’ve already purchased an annuity, this won’t apply to you.

Check if your pension is outside your estate. Your provider should also be able to tell you if it has the full range of income flexibility and death benefit options you need.

If you receive financial help from a benefit scheme this means there are no funds to pass on, however, there might be requirements applied to your partner or those financially dependent on you.

Take out life insurance

Consider taking out a life insurance policy.  These can be a speedy, tax-free payout for your family. When you pass away the beneficiaries will automatically receive the payout without being subject to IHT, provided its drafted correctly. This means you can nominate a beneficiary who is paid the full sum and you can insure your life for the estimated value of your inheritance bill.

Trusts or tax-efficient investments

For those open to riskier options, investing in shares listed on the Alternative Investment Market could be considered.

This list is made up of smaller companies that are often recently established and therefore can experience setbacks and be generally deemed more vulnerable. Most AIM stocks are exempt from IHT if they've been held for more than two years.

Alternatively, trusts offer a way to manage your estate when you pass away, keeping an element of control over what happens to your assets and how they can be used. The tax treatment of trusts can also mean they're useful for reducing the amount of IHT that will be paid.

However, the rules around IHT and trusts are complicated and – as with all of the above advice – it’s important to seek financial advice from a qualified professional.

For more information on IHT visit gov.co.uk