How to reduce your inheritance tax bill

Written by Carl Frost on 13th April 2022 | 8 minute read

The UK’s inheritance tax bill topped £5.32bn in the 2020/21 tax year. Families are paying more inheritance tax than ever before.

Our Wills, Trusts, Tax and Probate specialists explain some of the steps you can take to legitimately reduce your inheritance tax bill.

When do I have to pay inheritance tax?

Inheritance tax is usually a one-off tax due after your death, normally paid out of the value of your estate. Inheritance tax is payable on money, investments and any other assets within your estate, including your personal effects and household contents.

The individual threshold for inheritance tax is £325,000 (this is known as the ‘nil rate band’). If your estate is worth over £325,000 it may be liable for inheritance tax. Currently, inheritance tax is payable at 40% on the value of your estate above the £325,000 threshold.

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Ways to reduce your inheritance tax bill

With more and more estates liable for inheritance tax, it pays to be proactive and take steps to reduce your liability. Nobody wants to pay more tax than they have to! The more you can reduce your liability, the more you can leave to your family and friends.

There are a number of measures that can help minimise your inheritance tax liability, including:

Make a will

It’s important to have a valid will in place. Spouses and civil partners can transfer assets to each other tax free in their wills, which provides valuable relief from inheritance tax. However, if you die intestate (without a will), inheritance tax might be due on your estate.

How inheritance tax works if you’re married or in a civil partnership

If you are married or in a civil partnership, you might be able to use any unused nil rate band of your spouse against the value of your estate. After your death, your executor(s) (the people you have appointed to carry out the terms of your will) can apply for this. Therefore, married couples or civil partners may be able to pass on up to £650,000 free from inheritance tax to their beneficiaries.

Give assets away

You might be able to reduce your liability to inheritance tax by giving away assets during your lifetime.

These types of gifts are known as ‘potentially exempt transfers’. You must outlive the date of the gift by 7 years and receive no benefit from it in order for the gift to be excluded from the value of your estate following your death. If you die within 7 years and the gifts are worth more than the nil rate band, taper relief may apply, meaning the tax should be reduced the longer you survive.

Make plans for what happens to your house after your death

If you own a house and want to pass it on to a direct descendant after your death (such as your children or grandchildren), the residential nil rate band allowance may apply. The residential nil rate band provides relief from inheritance tax. At 6th April 2021 the allowance was £175,000 and the government announced it would remain until 2025-26.

Make gifts that are exempt from inheritance tax

Each financial year you are allowed to make gifts of up to £3,000 (in total, not per recipient) free from inheritance tax. Even if you die within 7 years of making gifts within the allowance, they will be excluded from the value of your estate. You can also carry any unused allowance over to the next year, which means you could give away up to £6,000. Gifts of £250 or less to any number of people are exempt and do not count towards your annual allowance

Weddings are another opportunity to make tax-free gifts. Each parent of a bride or groom can give up to £5,000; grandparents or other relatives can give up to £2,500 and any well-wisher can give £1,000.

Give surplus income away

Another way of passing money to the next generation is to make gifts from your surplus income. Conditions apply, and it’s best to take professional advice to be sure that the gifts are made in the correct way.

Get relief on farm and business assets

You can receive relief from inheritance tax if you choose to pass on relevant business assets and some types of agricultural land or pasture during your lifetime. Again, seeking advice is essential. If the process is handled incorrectly, you could remain liable to pay inheritance tax on assets you’ve given away.

Put assets into trust

Trusts can be extremely useful if you have savings, investments or property you wish to pass on in a tax efficient way. If you place assets in to a trust, they can be excluded from your estate for inheritance tax purposes. Thus, trusts can help reduce your liability for inheritance tax and protect valuable assets. Trusts can seem complicated, but with the right legal advice, can be an efficient way of managing your assets and tax liability.

Leave money to charity in your will

You can reduce the rate at which inheritance tax is payable by leaving at least 10% of your estate to charity. Currently, inheritance tax is payable at 40% on the value of your estate above the £325,000 threshold. If you choose to leave 10% of your estate to charity, that rate is reduced to 36%. A solicitor can tell you if this is an efficient step to take in your individual circumstances.

Take out life assurance

If you are concerned about the amount of inheritance tax that may be payable on your estate, you could consider taking out a suitable life policy. Whilst it won’t reduce the amount of inheritance tax due on your estate, the payment from the policy could make it easier for your beneficiaries to pay the bill. You would need to have the policy written under trust to ensure that it doesn’t form part of your estate on your death. Our team of financial advisers here at Tees Financial can advise you on this.

Take professional advice

Your estate may be worth more than you think – many of our clients are surprised to find out just how much their estate is worth! Once you consider the value of your home and other assets, you might be liable for inheritance tax.