7 ways to reduce your inheritance tax bill

The inheritance tax threshold cap has been extended until 2028, which will result in higher tax bills for many - we look at how to keep you inheritance tax bill to a minimum.

The government collected £6.1bn in inheritance tax (IHT) bills for the 2021-2022 financial year – a 14% increase on the year before. The figure for this year already looks set to breach that, taking into account the IHT freeze until 2028, as announced in the autumn Budget.

According to the Office for Budget Responsibility, the bill could grow to £8.3bn by 2026.

The chancellor, Jeremy Hunt, announced that IHT, which is charged at 40% of a person’s estate above the tax-free allowance (also known as the nil-rate band) of £325,000, will be frozen until 2028. This had already been frozen until April 2026 by the prime minister, Rishi Sunak, when he was chancellor. The move will mark nearly ten years since there was a change to the IHT allowance; it has remained the same since 2009.  

In the months between April and October 2022 the Treasury raked in £4.1bn from IHT bills –  that’s a £500m increase from the same period the year before. 

The IHT bill was increasing even before the latest tax freeze, and now it’s estimated 10,000 more families could be dragged over the threshold. 

“This is another stealth tax and the case of the boiling frog is apt,” says Alex Davies, CEO and founder of Wealth Club. “Rampant inflation, soaring house prices and years of frozen allowances will magnify the tax take in the years ahead. More and more families are going to find themselves hit by death duties they might not have expected or planned for.”

But it’s not all doom and gloom. “The good news is that with some careful planning there are lots of perfectly legitimate ways you can eliminate or keep IHT bills to the minimum, so more of your wealth is passed on to your loved ones rather than being syphoned off by the taxman,” says Davies. 

Here’s everything you need to know to help cut your inheritance tax bill.

How can you minimise your inheritance tax bill?

Around one in 25 deaths results in an IHT liability, according to AJ Bell. But with IHT at a rate of 40% it can really eat into the money you leave behind, so taking action now is essential. It may be worth speaking to a financial planner for some of these because of the complexities involved. You can find one at unbiased or at Wayfinder, run by the Chartered Institute for Securities & Investment (CISI).

1. Make a will

“Making a will is the first step you should take,” says Davies. “Without it, your estate will be shared according to a set of pre-determined rules. That means the taxman might end up with more than its fair share.”

2. Take advantage of gift allowances 

This is the easiest way to pass your assets onto your loved ones without paying tax. These will be especially welcome now that we are entering a recession. But there are some things to consider. 

Anyone can give up to £3,000 of their assets to loved ones each tax year without that sum becoming liable for IHT, no matter when they die. If you didn’t use it last year, you can combine it and pass on £6,000. 

Gifts of £5,000 to children made in advance of a wedding are also protected from IHT; the figure decreases to £2,500 for grandchildren. 

But, if you die within seven years of making a gift, IHT will be payable on a sliding scale; if you die three to four years after giving the money, the IHT rate lowers to 32%. At six to seven years it falls to 8%.  

3. Put it in a pension 

The main purpose of a pension is to provide you with income in retirement. But you can also nominate beneficiaries should you pass away before you receive it. The nominations have to be submitted directly to your pension provider, and generally IHT isn’t payable. 

However, if you die after the age of 75 your beneficiaries will need to pay income tax on the money they take out of the pension. The rate depends on whether they are a basic (20%), higher (40%), or additional rate (45%) taxpayer. 

4. Invest in AIM shares 

AIM is a branch of the London Stock Exchange which allows investors access to smaller companies 

“Investing in some AIM shares also comes with IHT benefits, because many stocks on London’s junior market qualify for Business Property Relief,” says Laith Khalaf, head of investment analysis at AJ Bell.  However not all AIM shares qualify and you must hold the shares for at least two years to be exempt from IHT. 

5. Set up a trust 

Setting up a trust to hold your assets is another option to consider, which can be done via financial planner.

“The benefit is that whoever you appoint as the trustee can control the assets, rather than them being passed onto the beneficiaries right away. This might be useful if you are concerned about gifting assets to a loved one who is perhaps not renowned for their financial prudence, or perhaps to young grandchildren. 

“Trusts can be expensive to run and subject to tax charges, which together with their complexity generally makes them worthwhile in only a few circumstances,” Khalaf says.

6. Take out an insurance policy 

You can purchase an insurance policy that covers IHT liability. This should be written in trust, and you should seek help from a financial adviser to do so.

“This route offers you peace of mind that your beneficiaries won’t struggle with a huge Inheritance Tax bill when you die, but you are effectively paying at least part of that bill while you are alive through your monthly premiums, which can be substantial,” says Khalaf. “If you die quite young, you probably get a good deal from the insurance policy, but if you live to a ripe old age, you won’t.” 

7. Donate to charity 

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 to 36% from 40%.

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