The ultimate guide to cutting your inheritance tax bill

Inheritance tax (IHT) has a reputation as one of the most disliked taxes in the country. With a combination of higher property prices and a frozen tax-free threshold, the government has been collecting an increasing amount of IHT, with receipts for April 2024 up by 7.2 per cent compared with the same month last year.

IHT is normally charged at 40 per cent on all assets in your estate that are above the tax-free threshold. This is set at £325,000 but can increase to £500,000 if you leave your home to your children or grandchildren. People who are married or in a civil partnership can combine the value of their thresholds. Anything you leave to your spouse, civil partner or charity is not subject to IHT.

While there is no magic solution if your estate is worth more than the limit, several strategies can help you mitigate your liability – especially if you start planning well in advance.

Gifting

If you want to save tax while keeping access and control over your money, no IHT strategy is perfect – you will usually have to sacrifice something. Iain Mcleod, head of private client consultancy at St. James’s Place, says the first step of IHT planning involves trying to gauge how much money you need to live on, and how much you can afford to give away. This can be difficult. “Consciously or unconsciously, people tend to hold on to wealth, because they just don’t know how much they need for the rest of their lives,” Mcleod says.

Gifting assets while alive, however, is a very effective way to reduce IHT on your estate. If you live for seven years after making a gift, it will not be subject to IHT. Additionally, you can make £3,000 worth of gifts each tax year (“annual exemption”) and give up to £250 per person (“small gift allowance”) without them being added to the value of your estate. You can also give away as much as you like as long as these are regular gifts from your income that do not impact your living standards.

Read more: Tax-efficient gifting

Pensions

Pensions are very useful for shielding your money from tax. Not only are they generally exempt from your IHT calculation, but if you die before the age of 75, your beneficiaries can draw from them free of income tax. Making pension contributions or preserving your pensions and spending other assets first are both good IHT-saving strategies. Remember that while individual savings accounts are free of other taxes, they are subject to IHT.

Clare Moffat, pensions expert at Royal London, says the abolition of the lifetime allowance has made pensions even more appealing because as long as the beneficiaries move it into drawdown rather than taking it as a lump sum, there will be no tax charge to pay, no matter the size of the pot. The main caveat is that if you die after the age of 75, withdrawals are subject to income tax at the beneficiaries’ rate. This also applies to the pension tax-free lump sum if you haven’t taken it yet. You might be tempted to take it out at that point, but you will need a plan for the money, because just leaving it in a different account will only expose it to IHT. Meanwhile, there are limits to how much you can contribute to your pension in a year, and loading up your pension to reduce IHT is not always feasible or advisable.

Moffat adds that contributing to someone else’s pension, for example your children and grandchildren, using the “gifts from regular income” rule, is also a great way to cut IHT. The recipient will get tax relief, and even if they were to pass away unexpectedly, the money would be free of IHT because it is held in a pension. It is also a straightforward way to support your grandchildren’s financial future without having to worry about them getting access to a big sum when they are still young. 

Read more: Why you shouldn't load up your pension to avoid inheritance tax

Life insurance

An important part of IHT planning is making sure your beneficiaries have the necessary cash available to pay it when the time comes. This may sound counterintuitive, but Ian Dyall, head of estate planning at Evelyn Partners, describes a “catch 22” situation where you typically need to pay at least some IHT before you can obtain probate on an estate, but at the same time, certain assets such as property cannot be sold until probate is granted. This can take some time to be resolved and IHT bills accrue interest.

A whole-of-life insurance policy set into a trust is a way to ensure that your beneficiaries have the money to pay the bill. But you must make sure you can afford the premium and also evaluate it in light of your risk appetite and how it compares to other IHT saving strategies.

Read more: How to use life insurance to cut your IHT bill

Trusts

Trusts are a more advanced solution. They can be used if you know you are not going to need a certain sum of money when you are alive, but also do not want to give it to your beneficiaries outright. Broadly speaking, assets put into a trust normally stop being subject to IHT after seven years, and the value of any growth of the assets inside the trust is immediately outside the estate – although there are some complications and costs to keep in mind.

There are different trusts for different needs, depending on your circumstances and the level of personalisation you require. For example, a discretionary trust can be used if you want to retain control over which beneficiaries receive the money and when.

Read more: How to use trusts to mitigate inheritance tax

Aim shares

Certain investments offer IHT advantages. For example, if you invest in Aim-listed shares that qualify for business relief, the assets can become free of IHT if you have held them for two years at your death. 

Dyall says that people find Aim shares attractive because the assets become free of IHT more quickly than with other strategies such as gifting, and you still maintain access and control over the assets. On one hand, this can be useful for older people who worry about not living for seven years after making a gift. But on the other hand, older people tend to be more risk averse and Aim shares are not always suitable for them. 

“It’s a useful tool for the right people,” says Dyall. “But you have to think about the potential volatility. For a younger person who is happy to take the risk, has a longer time frame, and maybe has a dual objective of both investment returns and IHT saving, Aim works very well.”

Read more: The Aim 100 2023: A market overview