If you’re looking for the best ways to reduce and minimise the impact of inheritance tax on your estate, this guide covers ten smart and legally sound strategies.
From lifetime gifting to using tax-free allowances, there are many ways to keep more of your wealth in the family. Broken down into easy-to-digest sections, if you’re wondering how to avoid paying inheritance tax, this guide will strengthen your understanding of this topic.
Lastly, if you have a large estate, learning the different ways of minimising inheritance tax is essential for families looking to protect their wealth. Why hand over 40% of your estate to HMRC, when there are legal ways to reduce the impact of this levy on your beneficiaries?
Table of contents
Read on to learn how this levy works and discover some of the most effective ways to avoid inheritance tax in the UK.
What is inheritance tax & how much is it?
Inheritance tax is a levy applied to the value of your estate when you pass away. In the UK, the current threshold is £325,000. In simple terms, your estate carries a 40% tax burden if it exceeds the above figure. However, there are various exemptions and reliefs available to everyone. This includes various ways of reducing or mitigating inheritance tax. For example, the nil-rate band, the 7 year rule, inheritance tax taper relief and the annual gifting allowance.
What’s included in your taxable assets?
When an individual passes away, the leave behind and estate. This is the accumulation of property, investments and other assets. It’s the responsibility of the executors named in the Will to calculate the value of the estate. This means adding up the total value of all property, savings, possessions and investments, then subtracting any debts or liabilities. The result shows whether any tax is owed.
In the UK, the list of what’s included in your taxable assets for inheritance tax is summarised below:
- Property
- Cash
- Investments
- Vehicles
- Business interests
- Personal possessions
Before calculating any tax owed, liabilities such as outstanding debts or funeral expenses are deducted from the estate. As you now understand, the impact of this tax on your estate could be substantial. As a result, you will now understand why people try and learn how to minimise the inheritance tax burden on your estate through careful long term planning and wealth management.
Can you avoid paying inheritance tax?
Yes, in many cases it is possible to reduce your bill, or avoid paying inheritance tax on your estate. These include setting up a trust, gifting property to your children, or making use of the 7 year rule to avoid a large tax charge on your beneficiaries inheritance. Furthermore, you can also reduce the tax due on your estate by making use of the available allowances in the UK like the Nil-Rate band and the Residence NilRate Band. Lastly, you can also consider using Equity Release to pass on an early inheritance in a tax efficient manner. If you’re looking for the best ways of reducing the amount of taxes due on your estate when you pass, keep reading this guide to learn more.
Example: Mike & Sarah
Mike and Sarah own a home, have some investments, and a couple of pensions. When Sarah dies, Mike inherits everything. No tax is due because spouses are exempt. Years later, when Mike passes away, the estate is passed to their children.
At this point, the executors need to:
- Value the home, savings, and other assets
- Subtract debts, such as a remaining mortgage
- Calculate whether the estate exceeds the combined allowance
If the total is above the threshold, the excess may be taxed. But Mike and Sarah planned ahead. They used their allowances properly, made gifts during retirement, and set up a life insurance policy in trust. As a result, less tax was owed, and more of the estate went to the children.
What are the best ways to reduce inheritance tax?
The best ways of reducing or eliminating the amount of inheritance tax due on your estate, is determined on an individual basis. In summary some of the best overall strategies for avoiding inheritance tax are using trusts, making use of taper relief, life insurance policies or even giving to charity. For some, more complex trusts like discounted gift trusts, loan trusts and offshore investment bonds are the best way to mitigate the impact of tax on your estate.
Let’s get started with our list of 10 of the best ways to avoid paying tax on your estate the UK. You’ll learn about the easy to access exemptions and reliefs, along with some of the more advanced planning tools people use to minimise the risk of paying a large inheritance tax bill.
To summarise, these are:
- Understanding your allowances
- Making use of gifting
- Considering regular gifting from income
- Setting up a trust
- Taking out a life insurance policy
- Spending your money or gifting assets
- Business property relief
- Leaving a portion of your estate to charity
- Understanding the seven-year rule
- Considering equity release schemes
Let’s examine each way of reducing the amount of tax owed by your estate when you pass. . Below, we provide insights into the ways to avoid this tax and some examples to cement your understanding.
1. Understand the nil-rate bands
The nil-rate band (NRB) and residence nil-rate band (RNRB) are the first two allowances you can use to avoid paying inheritance tax. The NRB is a threshold under which your estate isn’t taxed.
At the same time, the RNRB applies to your primary residence if direct descendants inherit it.
You can plan to minimise or reduce inheritance tax by understanding and using these allowances. Getting specialist inheritance tax advice will help you understand the complexities of this topic.
- The current NRB is £325,000 per person and can be transferred between spouses
- The RNRB can add up to £175,000 extra allowance when passing on your home
- Estates above £2 million may see the RNRB gradually reduced (tapered)
- Making use of both allowances could shelter up to £1 million from taxation for a couple
Example of using the nil-rate band to reduce inheritance tax
A couple can combine their NRB and RNRB allowances to shield a larger portion of their estate from inheritance tax, potentially saving their beneficiaries a significant amount in tax.
It’s worth noting the forthcoming changes to the inheritance tax thresholds and nil rate bands.
2. Using your annual gift allowances
Where possible, to help mitigate or reduce the impact of inheritance tax, you can use your annual gift allowances and exemptions to reduce your taxable estate.
Firstly, you can give away assets or cash within the annual gift allowance each year without incurring taxation.
Secondly, the seven-year rule for potentially exempt transfers (PETs) means gifts made more than seven years before your death are not subject to taxation.
- The annual gift allowance is £3,000 per tax year
- You can carry forward the unused allowance from the previous year
- Gifts on marriage or civil partnership are exempt up to set limits
- Small gifts of up to £250 per person are also exempt from inheritance, if no other exemption is used
Example of how to minimise inheritance tax with gifting
A parent gifts each of their children a sum annually within the gift allowance, reducing their estate’s value over time and potentially saving on inheritance tax.
- External resource: Gifts and exemptions from inheritance tax
3. Consider regular gifting from income
Gifting from surplus income can reduce your estate’s value without affecting your desired standard of living.
However, these gifts must meet certain conditions to be exempt from taxation. Tracking and documenting these gifts will help ensure they qualify for the exemption.
- Gifts must be made from income, not capital
- They should form part of a regular, consistent pattern
- Your usual standard of living must be maintained
- Keep clear records showing income, outgoings, and gifted amounts
Using gifts to help reduce inheritance tax
Grandparents regularly gift part of their pension income to grandchildren, which qualifies as exempt, thus reducing the taxable estate.
- Related reading: The normal expenditure out of income exemption
4. Using trusts to avoid paying inheritance tax
Trusts are effective tools for managing and protecting assets and help to mitigate this levy.
Each type of trusts offers different inheritance tax planning options, some with flexible structures, and others more restrictive. Furthermore, they are often considered as one of the key parts of the estate planning process.
As a result, they can help ensure your assets get distributed according to your wishes without, in many instances, increasing the value of your taxable estate.
What are the best types of trusts for mitigating inheritance tax?
Of course, the ‘best’ type of trust to mitigate and manage your estate’s tax position, depends upon various factors.
- Discretionary trusts can remove assets from your estate if set up correctly
- Bare trusts pass assets directly to beneficiaries but offer less control
- Trusts may still trigger charges, so professional advice is essential
- Used properly, trusts can reduce tax while protecting family wealth
- Discounted Gift Trusts: Immediate estate value reduction
- Flexible Reversionary Trusts: Controlled, tax-efficient asset distribution
- Loan trust: Retain access, shift growth tax-free
As you can see, the options are pretty vast. Using Discounted Gift Trusts as an inheritance tax reduction tool is one option. On the other hand, Flexible Revisionary Trusts offer another way of mitigating inheritance tax.
Example of using trusts
A discretionary trust can be set up to fund grandchildren’s education while keeping those assets out of the estate for tax purposes, thus reducing the overall liability.
- Related reading: Trusts & inheritance tax (GOV.uk)
5. Taking out a Life Insurance policy in trust
A life insurance policy written in trust can help to reduce an inheritance tax bill levied on your estate without increasing it’s value.
Properly setting up the policy ensures it remains outside the estate, thus avoiding inheritance tax. Therefore, we strongly recommend getting professional advice before making any decisions.
How does this help you to reduce inheritance tax?
- Policy pay-outs go directly to beneficiaries, not into your estate
- Helps your family cover a bill without selling assets
- Speeds up access to funds by avoiding probate delays
- Premiums may be treated as exempt gifts if paid from surplus income
Example of writing a life insurance policy in trust
A life insurance policy is written in trust, ensuring that the payout helps you avoid inheritance tax, reducing the financial burden on beneficiaries while keeping the policy outside the taxable estate.
6. Spending your money or gifting assets
Spending your money or gifting assets can reduce your estate’s value, reducing your liability. This approach requires balancing avoiding paying inheritance taxes, with sufficient financial resources for personal needs and retirement.
It’s important to consider personal circumstances and future financial security when planning such gifts or expenditures.
What is this a good strategy to avoid inheritance tax?
- Reducing your estate through spending can lower the potential tax on your estate
- Large lifetime purchases may also indirectly benefit your heirs
- Gifting valuable items, like art or jewellery, can move them outside your estate
- Always leave enough to maintain your lifestyle and cover future care costs
Example
A retiree gifts valuable artwork to family members and makes charitable donations, reducing the estate’s value while ensuring they have enough funds for a comfortable retirement.
7. Using Business Property Relief to minimise inheritance tax legally
Investing in assets that qualify for Business Property Relief (BPR) significantly reduces or eliminates this tax due on those investments.
Preserving wealth & protecting assets
These investments must meet specific conditions and have certain risks, requiring careful consideration and planning.
However, they can be a strategic way to preserve more of your wealth for future generations.
- Qualifying BPR assets are typically shares in unlisted trading companies or certain AIM-listed shares
- Assets must be held for at least two years to benefit from relief
Example of using Business Property Relied to minimise your inheritance tax liability
Investing in a small business can qualify for BPR, potentially exempting the investment from taxation after two years, thus reducing the overall taxable estate.
8. Gifting money to charity
Gifting money to charity reduces inheritance tax and therefore, the size of the levy applied on your remaining estate. If you leave at least 10% of your net estate to charity, the tax rate on the rest can drop from 40% to 36%.
This supports causes you care about and benefits your heirs by reducing the overall tax burden. Charitable legacies are a simple, effective way to do good and preserve more of your estate.
What are your options?
- Gifts to registered UK charities are 100% exempt from inheritance tax
- Leaving 10% or more of your net estate can lower your rate to 36%
- Charitable donations must be clearly stated in your will to qualify
- Reduces tax while supporting organisations you value
Example of how to reduce inheritance tax by giving to charity
An individual leaves 10% of their estate to charity, reducing taxation on the remaining estate and aiding a cause they care about.
9. Use the 7-year rule & taper relief to avoid inheritance tax
One of the most effective ways to reduce inheritance tax is to give assets away during your lifetime and survive for at least seven years after doing so. If you meet that timeframe, the gift is usually no longer counted as part of your estate.
This inheritance tax reduction strategy works best when planned early. Larger gifts made sooner have more time to move outside your taxable estate, potentially saving your beneficiaries thousands. It’s especially useful when passing on property, investments, or significant lump sums.
Key points for understanding the 7-year rule
- Gifts become exempt from taxation if you live seven years after making them
- If you die within seven years, taper relief may reduce the tax owed
- The rule applies to gifts of any size, not just cash
- Keep records of what was given, to whom, and when, for your executors
Example of using the 7 year rule to mitigate paying inheritance tax
A parent gifts £200,000 to their daughter and lives another eight years. The full amount falls outside their estate, and no inheritance tax is due.
External resource: Inheritance tax on gifts – the 7 year rule
10. Using equity release plan for inheritance tax
Equity release allows homeowners to unlock cash from the value of their homes, reducing the estate’s value and helping to lower their tax burden.
However, it’s essential to consider the costs and potential impacts of what you leave to your beneficiaries. There are many myths about equity release and a lot of false information out there, so always seek professional advice before making decisions.
Key facts about this IHT reduction method
- Releasing equity reduces the value of your estate for tax purposes
- Funds can be gifted or used during your lifetime to lower taxable assets
- Interest on lifetime mortgages can grow quickly, affecting what’s left
- Modern plans are regulated and more flexible, but advice is crucial
Example of using equity release to plan for inheritance tax
A homeowner uses an equity release scheme to access funds for living expenses, which reduces the home’s value in the estate and thus the inheritance tax liability.
Summary: How to avoid inheritance tax with the right advice
Inheritance tax can take a bigger chunk out of your estate than many people realise. But with early planning and the right approach, it’s possible to pass on more of your wealth and reduce the stress on your loved ones.
Here’s what we can help you with:
- Reviewing your estate and understanding your current exposure
- Making tax-free gifts in the right way, at the right time
- Using allowances and reliefs that often go unused
- Planning to avoid last-minute decisions or costly mistakes
Building a long-term strategy that protects your family’s future. If you are concerned about the impact of this tax on your estate, talk to one of our experienced inheritance tax advisers today by calling 01329 550190. We will help find out how to avoid inheritance tax on your estate.
Frequently asked questions
To legally avoid inheritance tax in the Uk, use your allowances, gift money early, and plan with care. Lifetime gifts, certain investments, and writing a will all play a part. Some families save large sums by acting early.
Can I gift my house to my children to avoid inheritance tax?
You can gift property to your children to avoid paying inheritance tax, but it depends on how you do it. If you still live there without paying rent, it may be classed as part of your estate. If you move out or pay market rent, it could be treated as a valid gift over time.
Can I put my house in trust to avoid inheritance tax?
It’s possible, but not always effective. Some trusts reduce the size of your estate, others don’t. Trusts can trigger other tax charges, too. Whether it works depends on the type of trust, your age, your goals, and how much control you want.
What is taper relief and how does it work?
Taper relief for inheritance tax applies to gifts made more than a set timeframe before death, reducing any inheritance tax due on a sliding scale. For example, a parent who gifts £100,000 9 years before they die, will pay less inheritance tax than one who dies within 3 years.
How can a financial adviser help me avoid paying inheritance tax?
An experienced inheritance tax adviser can map out your allowances and avoid common IHT planning mistakes. Furthermore, they can recommend IHT reduction strategies tailored to your family. They’ll also help balance tax efficiency with access to income, so you don’t compromise your lifestyle.
Can I avoid inheritance tax if I downsize my home?
Downsizing may help indirectly. If the proceeds are gifted and you live seven years, they could fall outside your estate. However, simply selling a larger home doesn’t reduce your taxable estate unless you act on the funds with careful planning.