Over the last decade, the number of people affected by Inheritance Tax has risen significantly. Luckily, it’s often possible to reduce how much of your wealth goes to the taxman. But it requires careful estate planning. With the right financial plan, you can reduce Inheritance Tax and leave more to your loved ones.

Inheritance Tax is paid on your estate upon your death should it exceed certain thresholds. Your estate brings together all of your assets. This may include savings, property and investments, as well as material items. The first step is to understand whether your estate will be liable for Inheritance Tax. There are two thresholds to keep in mind:

• The current nil-rate band is £325,000. If the total value of your estate falls below this, no Inheritance Tax is due.
• If you’re passing on your main home to children or grandchildren, you can also take advantage of the residence nil-rate band. This will add £150,000 (rising to £175,000 in 2020/21) to the above rate.

If you’re able to take advantage of both these thresholds, you can effectively pass on £475,000 without worrying about Inheritance Tax. You can leave unused allowances to a spouse or civil partner. As a result, children and grandchildren can potentially inherit up to £1 million free from Inheritance Tax from 2020/21.

Should Inheritance Tax be due, the standard rate is 40%.

Inheritance Tax on the rise

HMRC are collecting more in Inheritance Tax than ever before.

Only around 5% of estates pay the tax. But some people are finding themselves exceeding thresholds unexpectedly. During 2018/19. £5.4 billion was collected in Inheritance Tax. Just five years before, in 2013/14, the total amount was £3.4 billion. This rise is despite nil-rate bands gradually increasing.

So, what’s caused the rise? Many middle-class families are now finding that they need to pay Inheritance Tax. This is down to rising wealth, particularly the value of property. As a result, you may find you’ve inched over the threshold without realising.

Reducing Inheritance Tax bills

If you find your estate is likely to be liable, there are ways you can reduce Inheritance Tax bills.

1. Write a will

If you haven’t already, writing a will is the first crucial step. Without a will in place, your estate may be distributed in a way that doesn’t match your wishes. A will can also be used to reduce Inheritance Tax. For example, ensuring your main home goes to your child or grandchild can mean you’re able to use the residence nil-rate band.

2. Use your gifting allowance

Giving away some of your wealth now can be rewarding. It may mean your loved ones are able to reach goals sooner than if they were waiting for an inheritance. It also means you get to witness the security and joy it brings.

However, there is something to keep in mind before gifting. Should you give a gift and pass away within seven years, the gift may still be considered part of your estate for Inheritance Tax purposes. As a result, these are known as potentially exempt transfers (PETs).

But there are some gifts that are immediately outside of your estate:

• Up to £3,000 each tax year
• Up to £250 per person each tax year, as long as you have not used another exemption on the same transfer
• Wedding or civil ceremony gifts up to £1,000 per person, this increases to £2,500 and £5,000 for grandchildren and children respectively
• Payments that help with another person’s living costs, such as an elderly relative or child

3. Make gifts out of your excess income

In addition to the above, you can also make gifts out of excess income. For gifts to qualify, they must form part of your normal expenditure and not reduce your standard of living. If you decide to take advantage of this, it’s important you keep good records.

4. Place assets in a trust

Placing assets within a trust can remove them from your estate for Inheritance Tax purposes. In some cases, you’ll still be able to take an income from assets in a trust.

There’s more than one type of trust and it’s often an irreversible decision. So, it’s important to fully understand what steps you’re taking before proceeding. If you’d like to use a trust to reduce Inheritance Tax, please contact us to discuss your options.

5. Take out life insurance

This option doesn’t reduce Inheritance Tax but means it’s not taken out of your estate. Instead, you take out a life insurance policy that will pay a lump sum on your death, paying the IHT bill. It means your estate can be passed on to beneficiaries as you wish.

One crucial point to make here is that the life insurance policy will need to be placed in trust. Otherwise, it will count as part of your estate and actually raise the amount of Inheritance Tax due.

6. Leave a charitable legacy

Leaving a charitable legacy can reduce the rate of Inheritance Tax you pay. If you leave more than 10% of your entire estate to a good cause, the rate will reduce from 40% to 36%. Depending on the size of your expected tax bill, this could reduce it. If there are charities that you want to support, it can be a win-win situation.

7. Spend it now

Finally, spending your money on you is an option. Reducing the overall value of your estate will reduce the amount owed when you pass away. If your estate reduces in value below the nil-rate bands, you won’t have to pay any Inheritance Tax at all.

If you’d like to discuss how to reduce Inheritance Tax and leave more behind for your loved ones, please get in touch.

Please note: The Financial Conduct Authority does not regulate Tax and Estate Planning.