Inheritance tax bill burden nearing ‘unprecedented levels’ – how can you reduce your IHT bill?

Inheritance tax (IHT) receipts for April rose by £0.1 billion, with a record annual payment of £6.7 billion forecast for this year.

Dubbed Britain’s ‘most hated tax’, IHT has long been seen as a tax on the super-rich, but newly published data from HMRC reveals more people are being dragged over the threshold and being forced to pay the unpopular levy. 

So much so, experts say the toll faced by families is reaching levels not seen before - reaching its highest level in over 20 years.

The total annual sum is more than double the £2.9 billion paid in 2011/12.

The levy is expected to generate more money for the Treasury, with IHT takings forecast to increase to £7.8 billion “within the next five years, according to experts.

Rising house prices and a freeze in the IHT threshold are some of the main drivers for the increased amount levied. 

Rising house prices mean the number of inheritance tax receipts has hit its highest level in 20 years, with 41,000 liable to pay the tax in 2022/2023 – an increase of 24% from the year before. Nearly twice as many people are now paying IHT compared to the 2018/19 tax year when only 22,000 people paid the levy.

In the Autumn Budget, chancellor Jeremy Hunt said IHT rates will be frozen until 2028, having remained at the same level since 2009.

Rachael Griffin, tax and financial planning expert at Quilter, says: “The Chancellor’s extended IHT threshold freeze is already raking in a significant amount by stealth.”

“Historically IHT was viewed as a tax only for the very wealthy. However, with house prices remaining at elevated levels while both the nil rate band and residence nil rate band are frozen until 2028, many families that do not consider themselves to be wealthy could find themselves facing an unexpected IHT bill,” she adds.

We look at how you can potentially slash your IHT bill. 

How can you minimise your inheritance tax bill?

Around one in 25 deaths results in an IHT liability, according to the investment platform 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 the below tips 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 the allowance 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 drops 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 IHT isn’t normally payable. 

“Pensions can be a valuable tool when passing down wealth because they sit outside your estate for IHT purposes and as of April 2023, the lifetime allowance will be removed, so there is no limit on how much you can save over your lifetime,” says Barham.

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 that 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. Mind your ISA 

“One of the great IHT threats arguably comes from where you least expect it: your ISA,” says Davies. “Whilst tax efficient in so many other ways, ISAs form part of a person’s taxable estate along with other savings, investments and possessions, so up to 40% of could be eaten up by inheritance tax rather than passed to your loved ones.”

As an alternative, you could invest in certain AIM shares within your ISA. AIM shares, as we mentioned above, qualify for Business Property Relief, so provided you hold them on death and for at least two years they should be free of IHT. 

6. Set up a trust 

Setting up a trust to hold your assets is another option to consider, which can be done via a 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,” says Khalaf. “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.

7. 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’ll probably get a good deal from the insurance policy, but if you live to a ripe old age, you won’t.” 

8. 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 from 40% to 36%. Use the government calculator to work out how your estate could qualify for the reduced rate.

With additional contributions by Tom Higgins.