If you are concerned about the potential impact of inheritance tax (IHT) on your estate, read this guide covering ten different ways to avoid it entirely.
An unexpected or unplanned IHT bill could impact your estate and the financial value of your assets you leave behind – your legacy.
Early planning is crucial to reducing your bill. Understanding and implementing certain strategies can help protect your legacy and allow you to avoid IHT entirely.
Keen to learn about the different ways to avoid inheritance tax? Keep reading.
What is IHT?
Inheritance Tax (IHT) is a tax on a deceased person’s estate, which includes property, possessions, and money.
After death, executors calculate the total value of all assets and subtract any liabilities.
The resulting amount, known as the estate, is subject to IHT. Read your updated list of our inheritance tax FAQs to learn more about this topic.
Which assets are included in your estate?
Generally, any valuable asset should be included in your estate for inheritance tax purposes. If jointly held, only your share is included.
Assets included are:
- Property
- Cash held in bank accounts
- Investments and shares
- ISAs
- Antiques and jewellery
- Personal chattels
- Vehicles
- Life insurance payouts (not in trust)
- Gifts
Note: The asset value is determined as of the date of death.
What assets are not included in your estate?
Some assets fall outside your estate and are not subject to inheritance tax. These include:
- Most pension plans
- Life insurance (held in trust)
- Trusts in general
Outstanding liabilities are repaid from existing assets, reducing the estate’s value for IHT. Funeral expenses are usually allowable deductions from the estate for IHT purposes.
Taking stock of the above sets you on the path to preserving your wealth and paying less tax.
What are the different ways to avoid IHT?
Let’s get started with our list of 10 ways to avoid your IHT bill legally.
To summarise, these are:
- Understanding your IHT allowance
- Making use of gift allowances
- Considering regular gifting from income
- Setting up a trust
- Taking out a life insurance policy
- Spending or gifting assets
- Investing in IHT efficient investments
- Leaving a portion of your estate to charity
- Using a pension to pass on wealth
- Considering equity release schemes
Let’s examine each. Below, we provide insights into ways to avoid IHT and some examples to cement your understanding.
1. Understanding your IHT allowance
The nil-rate band (NRB) and residence nil-rate band (RNRB) determine your inheritance tax liability. 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 reduce or avoid IHT by understanding and using these allowances. Getting specialist inheritance tax advice will help you understand the complexities of this topic.
Example: 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.
2. Making use of gift allowances
To help avoid IHT, 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 IHT.
Secondly, the seven-year rule for potentially exempt transfers (PETs) means gifts made more than seven years before your death are not subject to IHT.
Example: 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.
3. Considering 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 IHT. Tracking and documenting these gifts will help ensure they qualify for the exemption.
Example: Grandparents regularly gift part of their pension income to grandchildren, which qualifies as exempt from IHT, thus reducing the taxable estate.
4. Setting up a trust
Trusts are effective tools for managing and protecting assets and help to avoid IHT.
Different types of trusts offer various tax benefits and flexibility and are a key part of the estate planning process.
As a result, they can help ensure your assets get distributed according to your wishes without increasing the value of your taxable estate.
Example: A discretionary trust can be set up to fund grandchildren’s education while keeping those assets out of the estate for IHT purposes, thus reducing the overall IHT liability.
5. Taking out a Life Insurance policy in trust
A life insurance policy written in trust can provide funds to cover an inheritance tax bill without increasing the estate’s value.
Properly setting up the policy ensures it remains outside the estate, thus avoiding additional IHT. Therefore, we strongly recommend getting professional advice before making any decisions.
Example: A life insurance policy is written in trust, ensuring that the payout covers IHT, 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, lowering your IHT liability.
This approach requires balancing IHT reduction 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.
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. Investing in IHT efficient investments
Investing in assets that qualify for Business Property Relief (BPR) significantly reduces or eliminates IHT due on those investments.
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.
Example: Investing in a small business can qualify for BPR, potentially exempting the investment from IHT after two years, thus reducing the overall taxable estate.8. Leaving a portion to charity
8. Gifting money to charity
Gifting money to charity is exempt from IHT and can also reduce the IHT rate on your remaining estate.
This supports charitable causes and benefits your heirs by reducing the tax burden.
Example: An individual leaves 10% of their estate to charity, reducing the IHT rate on the remaining estate and aiding a cause they care about.
9. Using a pension to pass on wealth
Pensions can efficiently transfer wealth outside your estate and help to reduce or avoid an IHT bill.
Example: A pension is left to children, avoiding IHT and providing them with tax-efficient benefits, ensuring more wealth is preserved for the next generation.
10. Equity release
Equity release allows homeowners to unlock cash from the value of their homes, reducing the estate’s value and helping to lower IHT.
However, it’s essential to consider the costs and potential impacts on 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.
Example: 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 IHT liability.
Conclusion – the different ways to avoid inheritance tax
And there we have it—10 ways to avoid inheritance tax. If you are concerned about the impact of this tax on your estate, talk to one of our experienced IHT advisers today by calling 01329 550190