Do you face ‘double whammy’ inheritance tax blow? How to lessen the impact

Thousands more estates will be hit with a double inheritance tax (IHT) blow within two years – but there are ways you can lower the bill for your loved ones.

The number of estates worth more than £2 million which will start to lose their residence nil-rate band is set to rise by 76% from 3,620 in 2023 to 6,400 by 2028, according to new research by wealth management firm Quilter.

This figure will increase to over 16,000 by 2031 due to frozen IHT thresholds and pensions being subject to IHT from April 2027. Rising house prices will also increase the value of peoples' estates.

Try 6 free issues of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

IHT is usually payable on estates worth £325,000 or more but this is topped up by an additional £175,000, known as the residence nil-rate band, if you are leaving your home to a child or grandchild. You can pass this £175,000 allowance to a partner if you die.

This means couples who are married or in a civil partnership could leave up to £1 million to loved ones and they wouldn’t owe any IHT.

However, for every £2 your estate is worth more than £2 million, you lose £1 of this residence nil-rate band until it disappears. This means estates left by a single person worth £2.35 million receive no residence nil-rate band, while for couples it’s £2.7 million.

With IHT tax bands frozen at their current levels until 2031 and pensions falling into the scope of IHT from April 2027, more estates will start losing this allowance, Quilter said.

Shaun Moore, tax and financial planning expert at Quilter, said: “Many estates are likely to be hit by the double whammy of pensions being brought into scope for IHT and frozen tax allowances.

“IHT is already a devilishly complicated tax to navigate, and given the rise of asset prices in the past decade or so, many more are having to adapt their strategies in real time to help mitigate it and pass on wealth efficiently to future generations.”

How to reduce your estate to less than £2 million

If you believe you could be set to lose some or all of your residence nil-rate band, because your estate is likely worth more than £2 million, you might want to plan ahead now to protect your wealth.

1. Gifting

You can give up to £3,000 away each tax year without it being added to the value of your estate as well as up to £5,000 to someone getting married or entering into a civil partnership.

Gifts worth up to £250 can be given to as many people as you like each tax year, so if you have eight grandchildren, you could give them £250 each and remove £2,000 from your estate.

However, you can’t use this allowance if you’ve used another allowance on that person. So, you wouldn’t be able to pay someone a £250 gift and another £3,000 gift in one tax year and benefit from both the small gift and annual allowances.

You can also give an unlimited amount of money away and your estate won’t be subject to IHT if you live for seven years after giving it.

Moore said: “Lifetime gifting remains one of the most reliable ways to bring an estate back below the threshold.”

Do note, it’s important to keep records of when and how much you’ve gifted as this will make it easier for your executors to disclose any to HMRC.

2. Charitable giving

Donations to charity left in your will are taken off the value of your estate before IHT is calculated.

If 10% or more of your estate is donated to charity, your overall IHT rate will fall to 36% rather than the standard 40%.

3. Downsizing

You can move to a less valuable home and release some of the equity tied up in your current property to lower the value of your estate.

You will have to give away or spend this equity to actually reduce the size of your estate though and note the seven year rule may apply if you’re giving away money outside of your allowances.

There are also the costs associated with moving home such as estate agent fees, surveys and paying removal firms to factor in.

Rebecca William, financial planning divisional lead at wealth manager Rathbones, said: “Options such as downsizing later in life can help, provided people understand what they can afford to give away and when.”

4. Remove pension wealth earlier

With pensions subject to IHT from April 2027, you may want to start drawing down on your pension or take your tax-free lump sum earlier than planned to release funds from your estate.

Just make sure you’ve got a plan in place so it doesn’t leave you out of pocket down the line in retirement.

Tax-free lump sums can’t be added back into your pension once they’ve been taken out as well, so bear that in mind if you’re planning on withdrawing yours early.

5. Onshore bonds

Onshore bonds written in trust can be an effective way of reducing your future IHT liability if gifted to a family member.

As long as the giver survives seven years, there will be no IHT to pay.