How to minimise your inheritance tax bill

Fiscal drag will ensure that more people pay inheritance tax. Here’s how to minimise your bill.

People looking at wedding presents
Wedding gifts of up to £5,000 are exempt from IHT
(Image credit: © Getty Images/Tetra images RF)

In last week’s Budget it was announced that the inheritance tax (IHT) threshold is being frozen for another five years. This is set to drag thousands more people into paying the so-called death tax. The good news is there are plenty of things you can do to reduce any future IHT bills.

IHT is levied on your estate – all your assets from property to art to shares – after you have died. Estates worth less than £325,000 don’t pay IHT but 40% of the value above that amount is taken by the taxman. In addition to the £325,000 allowance you can also hand over up to £175,000 of a family home to direct descendants without paying IHT. The decision to freeze the allowances until 2026 will secure HM Revenue & Customs (HMRC) an estimated £985m of extra cash.

“Surging deaths related to coronavirus, combined with booming house prices, will push the death tax take to all-time highs next year and bring the annual haul to £6.6bn by 2026, up from £5.1bn last year,” says Harry Brennan in The Sunday Telegraph.

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The main IHT threshold of £325,000 hasn’t changed since 2009. “Had the government increased the main threshold in line with the rising cost of goods and services over time it would stand at almost £450,000 today,” says Brennan. Instead, thanks to frozen allowances, it is expected that over 36,000 estates a year will be liable for inheritance tax by 2026, up from 25,000 in recent years.

“Inheritance tax is known as Britain’s most hated tax for a reason,” Sam Collins, policy adviser at the Institute of Economic Affairs think tank, told The Daily Mail. “It is not only immoral as a form of double taxation but is a bureaucratic nightmare for families.”

Use your gift allowance

Thankfully there is plenty you can do to minimise a future IHT bill. Start by making the most of your annual gifting allowances. HMRC is keen to avoid anyone giving away their entire estate on their deathbed but you are allowed to give away set sums.

We can all give away up to £3,000 a year. On top of that you can also hand out up to £250 as often as you like – provided they aren’t going to the same people who got the £3,000. Wedding gifts are also exempt. In the year of the wedding parents can gift the happy couple £5,000, grandparents £2,500 and anyone else £1,000.

Anything you give away over that amount is subject to the seven-year rule. This means if you die within seven years of the gift it is still classed as part of your estate for IHT purposes. But this occurs on a sliding scale. If you die within three years of the gift – and your estate exceeds the £325,000 allowance – then it will be taxed at 40%. This falls to 8% six years after the gift and 0% if you die more than seven years later.

You can also give away as much money as you like out of your surplus income and it is immediately excluded from your estate. For example, if you earn £5,000 a month but only need £3,000 to cover your living costs you could give away the other £2,000 every month. It just mustn’t affect your standard of living.

Spouses and civil partners can hand their estates to their other halves without any of it being liable for IHT. Then, when the surviving partner dies, both of their allowances can be used. That means married couples and those in civil partnerships can potentially pass on up to £1m.

Finally, you can reduce the rate of IHT due on your estate by making a charitable donation. If you leave 10% of your net estate – that’s the amount over the IHT thresholds – to charity then the amount of IHT you pay on the rest falls from 40% to 36%.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings and credit cards to pensions, property and pet insurance. 

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping among many other titles both online and offline.