How to cut your Inheritance Tax bill


Updated on 25 April 2019

Inheritance Tax bills keep rising every year. Thankfully, it is possible to minimise the death tax, but proper planning is key.

Inheritance Tax bills

The Government took a record £5.4 billion in Inheritance Tax (IHT) receipts during the last tax year, official figures show. 

That represents an increase of £160 million on the previous year – which rose £400 million compared to the year before that – as grieving families are hit with ever larger tax bills.

Remarkably, the increase has come despite an increased tax break that sits on top of the current tax-free allowance.

The main reason for the growing inheritance tax take is rising property prices, which has notably increased the value of most people's estates.

It means you need to take steps to ensure your family isn't left with a sky-high IHT bill – and the sooner you start planning the better. 

Here's how to cut your costs.

Remember, Inheritance tax is just one of many taxes out there. If you're looking for a complete guide to cutting down your Income Tax, Council Tax and Capital Gains Tax bills, click here.

Tax relief: the nil-rate bands that matter

There are effectively two tax allowances you need to know about. 

First of all is the general nil-rate band, which covers anything up to £325,000.

The existing nil-rate band will remain at this level until the end of 2020/2021.

The second, known as the main residence nil-rate band, was introduced in April 2017.

It only applies when a main residence is passed to children or grandchildren after death.

It was initially worth £100,000, but is being gradually increased every year until 2020/2021 (next tax year).

At present it's worth £150,000 and will increase to £175,000 from next April.

This band sits on top of the existing Inheritance Tax threshold, so will create an effective threshold of £500,000 for individuals and £1 million for couples by 2020-2021.

It's estimated the change will save affected families around £200 million a year in total, or £1.5 billion by 2020/2021. 

What if I downsize?

The main residence nil-rate band still applies if someone downsizes or ceases to own a home.

For example, let’s say you choose to downsize from a home worth £200,000 to one worth £100,000.  

According to the Treasury, you can still benefit from the maximum allowance of £175,000 in 2020-2021 if you leave the home and £75,000 of other assets to direct descendants.

Unfortunately, many plan to leave their home to other family members like nieces, nephews, aunts or cousins. In fact, one in 10 people over the age of 55 have opted to pass their house on to their sibling, according to LV= Legal Services. 

Property plays a major role in inheritance tax (image: Shutterstock)

The most expensive homes

What's more, there will be tapered withdrawal of the main residence nil-rate band for estates with a net value of more than £2 million. This withdrawal will be at a rate of £1 for every £2 the estate is valued over the £2 million threshold.

So for example, if your estate is valued at £2.1 million, it would lose £50,000 of the new allowance.

Read about the other exemptions over at Inheritance Tax: new 'family home allowance' exclusions you need to know about.

Use a charity discount if you want to help others

There's a reduced rate of Inheritance Tax of 36% for those who leave 10% or more of the net value of their estate to charity.

Your loved ones won’t be any better off if you go down this route – you’ll just ensure that some of your bill goes towards a cause you care about, rather than to the Treasury! 

HMRC has even provided a calculator to work out how much you could save: click here.

If you want to leave money to charity in your will, there's never been a more important time to do it. Read How to make a cheap and free will to find out why.

Gifts can help you shift small sums tax-free

We all have a £3,000 limit each year for gifts, which is completely free of Inheritance Tax. What’s more, if you don’t use your allocation this year, it can be carried over to next year, so you can hand over £6,000 to a loved one, tax-free!

You can also give away £250 each to a number of people every year, though you can’t combine it with the £3,000 annual allowance. They are different exemptions.

Weddings also offer an opportunity to avoid Inheritance Tax. Parents can give their children £5,000 each as wedding gifts, £2,500 to grandchildren or great-grandchildren, or wedding gifts of £1,000 to anyone else.

There are hoops to jump through though. The gift must be made (or at least promised) on or shortly before the day of the wedding.

You can leave cash to a political party free of tax too. However, not all parties qualify – they will need to have at least two members elected to the House of Commons, or one member where the party received at least 150,000 votes.

Finally, regular gifts that come out of your income (say a monthly payment to a family member) are also exempt so long as they do not affect your standard of living.

You can give generous gifts related to weddings (image: shutterstock)

Potentially exempt transfers (PET) are key. Just don't die!

You can actually make additional gifts, above and beyond those detailed above, without the taxman trying to claim a slice. These are known as ‘potentially exempt transfers’.

All you have to do is live for seven years after making the gift. If you die within seven years of making the gift, and the total value of the gifts is valued at less than the Inheritance Tax threshold, then it will be added to the value of your estate.

However, should the gifts be valued at more than the Inheritance Tax threshold, then either the person receiving the gift or the person managing your estate will need to pay Inheritance Tax on its value.

All simple so far, but since this is Revenue & Customs we are dealing with, there’s room for a bit of added complexity! Should you die between three and seven years after making the gift, and the value of the gifts is valued at more than the Inheritance Tax threshold, then the tax due is reduced on a sliding scale.

For a full run-down on the ‘taper relief’, check out this section of the HMRC website, but the table below shows the sliding scale of relief:

Years between gift and death Tax paid
less than 3 40%
3 to 4 32%
4 to 5 24%
5 to 6 16%
6 to 7 8%
7 or more 0%

Don't forget your life insurance

If you have a life insurance policy, should you die, the payout to your relatives may actually be subject to Inheritance Tax.

That’s because the payout will be added to the value of your estate. What’s more, it can then take months before your family receives the cash. It’s all far from ideal.

However, you can have the policy written in trust. This basically separates the policy from the rest of your estate, which means that there will be no tax to pay. It also helps to speed up the process of your family receiving the cash.

Also take a look at this guide by Sarah Coles, personal finance specialist at Hargreaves Lansdown, on putting your affairs in order.

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