Nicole García Mérida
Inheritance tax (IHT) is often voted one of the least-popular taxes in Britain, and it’s likely to get even more attention in the years to come as rising house prices and fiscal drag send bills higher and draw more families into the IHT net.
The total amount collected by the government hit an all-time high last year at £7.5 billion (2023/24 tax year). Furthermore, the latest IHT receipts published by HMRC suggest we are on track for another record year in 2024/25.
Recent changes in the Autumn Budget are likely to exacerbate the effect going forward, after the chancellor extended the freeze on IHT thresholds until 2030 and brought inherited pensions and AIM shares into the IHT net.
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The rules on business and agricultural property relief were also reformed, prompting a sharp backlash from farming communities.
Despite this, there are still some steps you can take to cut your IHT bill and pass on more of your estate to your loved ones. We take a closer look.
1. Make a will
Making a will is the first step you should take. Without a will, your estate will be shared according to a set of pre-determined rules, known as intestacy. That means your loved ones may not receive what you want them to inherit.
Making a will also means you can specify things like who gets the family home. Decisions like this can impact how much inheritance tax is due. For example, if you leave the family home to your children or grandchildren, you may qualify for an additional tax-free allowance known as the ‘residence nil-rate band’ – more on that below.
2. Use your tax-free allowances
When you die, you can pass on an estate worth up to £325,000 before any inheritance tax is due.
If you leave the family home to a ‘lineal descendent’ such as a child or grandchild, you may also qualify for an additional £175,000 allowance, known as the residential nil-rate band. This additional allowance is tapered once your estate exceeds £2 million in value.
Married couples and civil partners can combine their nil-rate bands. This means a couple could theoretically pass on an estate worth up to £1 million to their children before any tax is due (£325,000 + £175,000 + £325,000 + £175,000).
Assets left to a spouse or civil partner are also exempt from inheritance tax. “But for those who are in a relationship but unmarried – whether co-habiting or not – the issue becomes more pressing,” says Ian Dyall, head of estate planning at wealth management firm Evelyn Partners.
“It could well be that many older couples in long-term relationships decide to tie the knot to make this problem go away, for a certain timespan at least,” he adds. Inheritance tax will still be due once both partners pass away and leave their assets to the next generation.
3. Gift assets in your lifetime
Giving away assets in your lifetime could help your loved ones pay less inheritance tax, but strict rules are in place to tackle tax evasion:
- Anyone can give up to £3,000 of their assets to loved ones each tax year without that sum becoming liable for IHT. If you didn’t use the allowance last year, you can combine it and pass on £6,000.
- You can give £5,000 to your children for their wedding, £2,500 to your grandchildren or great-grandchildren, and £1,000 to any other person.
- You can make further gifts as you please, but if you die within seven years of making the gift, IHT will be payable on a sliding scale known as taper relief.
You can also make gifts out of any excess regular income. Gifts from surplus income are not subject to inheritance tax, no matter how large the amount. But to qualify, the gift-giver must be able to prove the gift has come from income rather than capital. What’s more, the gift must not impact the giver’s quality of life.
4. Read up on changing pension rules
Historically, pensions have been a tax-efficient way to pass on wealth to loved ones, as inherited pensions currently fall outside of the IHT net. However, the rules are set to change in April 2027 after an announcement made in the Autumn Budget.
Dyall says: “The Budget rule change means retirees might not necessarily want to be sitting on a big pension pot when they die, as it will add to the value of the estate and could either create or add to an IHT liability.
“Moreover, under current rules, the pension IHT change could mean that some pots are ‘double-taxed’ if the holder dies at age 75 or older, because then the beneficiary could also be charged income tax at their marginal rate as they withdraw funds from the pension that has already been subject to IHT at 40%.”
For beneficiaries who are additional-rate taxpayers, this means they would receive just 33p for every pound of the inherited pension.
With this in mind, Dyall says retirees may want to consider drawing more heavily on their pension once they hit 75 rather than relying on other assets or savings to fund their lifestyle. Previously, many prioritised other savings because of the inheritance tax perks associated with pension pots.
The picture is complex, though, and largely depends on your personal circumstances. For example, if you decide to change your strategy and draw more heavily on your pension in response to the new rules, you need to weigh any IHT considerations against the income tax paid on pension withdrawals.
Dyall says this is especially true where the saver is “close to a big marginal tax step or paying the 45% additional rate of income tax”.
5. Consider investing in AIM shares
AIM is a branch of the London Stock Exchange that allows investors access to smaller companies. Historically, AIM shares have been exempt from IHT.
This is set to change from April 2026 after changes announced in the Autumn Budget, however AIM shares will still be more tax-efficient than other assets. Under new rules, the tax will be levied at 50%, giving an IHT rate of 20% (half the regular 40% rate).
With this in mind, it could be worth investing in AIM shares as part of a diversified investment portfolio. But bear in mind that AIM shares are often riskier than shares listed on the main stock exchange, as the businesses are smaller, less regulated and often more immature.
6. Be careful with your ISA
While ISAs are tax-efficient in many ways, remember that they still form part of your taxable estate when you pass away. This means up to 40% of your ISA could be eaten up by inheritance tax.
Furthermore, remember that ISAs lose their tax-efficient status on death (unless inherited by a spouse or civil partner). This means that the person you leave your ISA to will not be able to benefit from tax-free income and growth on the assets.
7. Take out a life insurance policy
If you are worried that your loved ones could face a large inheritance tax bill, taking out a life insurance policy could help them manage the liability. However, you need to have the policy written into trust, otherwise the payout will form part of your taxable estate.
“You pay the monthly premiums and when you die the trustees (your beneficiaries) can use the proceeds to promptly settle the IHT bill,” Dyall explains.
“This can also have the added benefit of saving executors some potential stress as it will provide accessible funds to settle the IHT liability with HMRC, which must be done before probate is granted,” he adds.
A financial advisor or legal expert will be able to provide you with further guidance on this process and whether it is right for you.
8. Donate to charity
Finally, if you donate at least 10% of your estate to charity, you could get a 4% discount on your IHT rate for the rest of your estate, lowering it from 40% to 36%. You can use the government IHT calculator to work out how your estate could qualify for the reduced rate.
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