5 Options to Reduce Inheritance Tax

inheritance tax forms

Inheritance tax is set to be a very big earner for the UK government in the next couple of decades as the baby boomer generation pass down homes and other assets with significant market value.

Inheritance tax is payable at 40% of the taxable gain so your liability could easily be several hundred thousand pounds especially in the south east where property values are so high.

Let’s take a look at some of the basics relating to Inheritance Tax and how we can reduce our liability.

How is Inheritance Tax Calculated?

The standard rate of inheritance tax is 40% and is charged on gains over and above your tax-free threshold. It also helps to understand that Inheritance tax (IHT) is a tax on the estate value and not on those that are in receipt of the estate. The estate will be taxed before it is transferred.

Understanding the Tax-Free threshold

There is no charge where assets are transferred to your spouse or civil partner, a charity or a community amateur sports club.

If the value of your estate is less than £325,000 then there’s no Inheritance tax to pay. £325k is the current Tax Free threshold.

If transferring your home to your children or grandchildren, then the £325,000 threshold increases to £425,000. This is due to something called the Residence Nil Rate Band (RNRB) and as the name would suggest its applicable to the transfer of “residence” or home not general property however just to confuse you the additional rate band can be applied across the estate if the value of your home is less than £425k.

The RNRB top up is £100k in 2017-18, increasing by £25k each year to a forecast £175k by 2020-21. Therefore by 2020-21 if your estate transfer includes your main residence then the tax-free threshold will be £500k (£325K +£175k RNRB top up).

Finally, if your estate (total) is worth over £2m the RNRB is tapered. For every £2 that your estate is over £2m the RNRB is reduced by £1.

Calculating and Paying Inheritance Tax

Let’s say you are leaving behind a home worth £1m and you are leaving it to your children. In this case your estate would benefit from an increased threshold of £425,000 with the balance being taxed at 40%.

£1m - £425k = £575k * 40% = £230k tax liability which is a substantial amount of tax. If you have a “Will” the executor of the Will should arrange for the IHT to be paid from funds in the estate or cash from the sale of assets if there isn’t any cash. IHT is due 6months after your death.

5 Options to reduce Inheritance Tax

There are a number of legitimate ways to reduce your IHT burden but you could also consider taking out an insurance policy to pay the IHT on your death which would then mean your assets wouldn’t need to be sold in order to meet the liability.

1. Getting a better tax rate - if you leave 10% of your estate or more to charity then the tax rate applied to any excess value (value above the applicable threshold) will be taxed at a reduced rate of 32% rather than the standard 40%.

2. Give it all away! – when you give a gift (money, property, possessions of value or you sell your home to your child for less than its worth) the gift is eligible for a “taper relief” depending how long you live after making the gift.

I will link to the HMRC info on gifts below but the taper ranges from 7years prior to death being at 0% to less than 3 years being taxed at the normal 40%.

One final point on gifts is that you can give £3k per tax year totally tax free with no IHT implications; this is your “annual exemption”. You can carry this exemption forward for one year only so if you didn’t give anything last year your annual exemption is £6k this year!
(again there are a few other rules on gifts that are outlined in more detail on the HMRC website – link below)

HMRC Link on Gifts https://www.gov.uk/inheritance-tax/gifts

3. Business Rate Relief – this is a powerful relief as it offers either 50% or 100% relief on the transfer of your business assets.

You can get 100% relief on a business or interest in a business (shares in an unlisted company).

You can get 50% relief on shares in a listed company (providing you own more than 50% of the voting rights which is not very likely), land, buildings or machinery used in a business you are a partner in or that are held in trust.

Note; to qualify for relief the business interest must have been held for at least 2years prior to death. More info can be found at the HMRC link below.

HMRC link on Business Rate Relief https://www.gov.uk/business-relief-inheritance-tax/what-qualifies-for-business-relief

4. Pay into a pension rather than a savings account - Under normal circumstances the transfer of pension asset is outside IHT and therefore tax free. This being the case if you have a large amount of cash in savings you could look to put the cash into a pension so its not included as part of your estate calculations for IHT purposes.

Note; if you are terminally ill this transfer may be challenged as the general principle is for the pension value to be outside IHT where there was a reasonable expectation you would have lived to claim the benefit yourself.

5. Use a Trust- This is often a very misunderstood area and for good reason as its complex but its not as wonderful as many believe it to be from a tax perspective. People read that assets held in a trust transfer with no IHT liability and suddenly everyone wants to open one, but its not quite that simple.

Since 2006 when you transfer assets into a trust you are making a disposal of ownership so you may be liable to capital gains tax if the assets have increased in value since your acquired them.
(normal CGT relief rules for your main residence would apply here – link).

Also, if the value of your transfer in the last 7 years exceeds the IHT nil rate band a 20% tax is immediately due. If you then are unfortunate enough to die within 7 years your estate will face a further charge of up to 20%.

So when would you use a trust?

Certainly, if you wish to delay the transfer of your assets to your children until they reach a certain age.

If you are not that old but have significant wealth and you could therefore reasonably expect to have a good period of time left to transfer assets into a Trust without exceeding the IHT nil rate in any 7 year period.

If you wish to setup a discretionary trust where a board of trustees manages your assets and distributes capital and income to future generations from the trust without ownership transfer.


IHT will be a significant revenue stream for the government in years to come but with a bit of careful planning you have several routes to avoid HMRC grabbing a big chunk of your estate.

Personally, I’m a big fan of using business assets as you can buy commercial or residential property and wrap it up in a Limited Company providing rental income. Providing you own the business for 2years prior to your death these assets will transfer with 100% relief.

Advice and planning can save you tens and even hundreds of thousands of pounds here.

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