UK Inheritance Tax (IHT) Planning

IHT is a tax which may be paid on your estate (your money, possessions and your share of any property) when you die, reducing how much value will ultimately pass to your beneficiaries.

IHT is currently applied to estates worth more than £325,000 - though this threshold is likely to change in future. When the value of your estate exceeds the limit, known as the ‘nil-rate band’, everything over the threshold is taxed at 40% (unless you’re leaving it to your surviving spouse, in which case no IHT usually needs to be paid).

The tax is levied on the worldwide assets of ‘UK domiciled individuals’. That means if you’re a UK citizen and you have a holiday home abroad, it still counts as part of your estate for IHT purposes. Similarly, if you’re a foreign national but have UK property or assets, you’ll be liable for UK inheritance tax if the value of those assets comes to more than the £325,000 limit.

Understanding the nil-rate band is key to it all. The nil rate band is, in effect, a personal IHT tax allowance. Every person who is subject to potential IHT has their own £325,000 allowance, and you’ll only become liable for inheritance tax if your estate exceeds that amount.

This allowance can be increased in certain circumstances, too. For example, if you were to leave your main residence to a direct descendant when you die, an additional ‘residence nil-rate band’ will be added.

Until 2028, the maximum residence nil rate band is frozen at £175,000. This gets added to your existing nil-rate band of £325,000 - so your estate could be worth up to £500,000 before any IHT is payable.

Let’s say you leave behind…

• Savings, investments and possessions worth £100,000

• Your main residence, worth £400,000

• The total value of your estate is £500,000, which would ordinarily exceed the nil-rate band. However, if you leave the property to a direct descendant, the residence nil rate band extends your allowance to £500,000 (£325,000 + £175,000).

• This means no inheritance tax would be due.

Note that if you co-own your property, only the value of your share will be counted among your estate. In the case above, if you had a 50% share in the house, it would be worth £200,000.

Being married or in a civil partnership can bring some major benefits when it comes to IHT. If your will passes all your assets to your wife, husband or registered civil partner, then there won’t normally be any IHT to pay. What’s more, your nil-rate band won’t be used at all – so your surviving partner can effectively double theirs.

It’s up to the legal personal representatives of the second spouse or civil partner to claim the transfer of the unused nil-rate band when the second partner dies. Doing so can significantly reduce the inheritance tax that’s due on assets passed down to your offspring, or other family and friends.

Here’s a quick example of how it works:

Mr Smith died in 2017, leaving his estate to his wife. As the assets passed to his spouse, none of Mr Smith’s nil-rate band was used. Mrs Smith then passes away in 2020, with a total estate worth £600,000 left to nieces and nephews.

As none of Mr Smith’s nil-rate band was used, 100% of it (£325,000) can be added to Mrs Smith’s own nil-rate band (also £325,000), increasing Mrs Smith’s nil rate band to £650,000.

As a result, no IHT needs to be paid.

If Mr Smith’s nil-rate band hadn’t been transferred, then £110,000 IHT would have to be paid. This is 40% of £275,000, the value of Mrs Smith’s estate (£600,000) less her own nil rate band (£325,000).

Given the rapid rise in house prices over recent decades, more and more people find their estates exceeding the IHT threshold even with the benefits of the residence nil-rate band.

Giving money or assets to your beneficiaries while you’re still alive is one of the most common strategies to pre-emptively reduce inheritance tax. However, there are a number of rules around what you can give, and when you can give it.

When the value of your estate is calculated, it will include the total value of certain gifts you made in the seven years before your death, or at any time if you continued to benefit from the gifted property thereafter (these are known as ‘gifts with reservation of benefit’).

Exempt transfers are gifts you can legitimately make at any time, without incurring any inheritance tax. These include:

• Gifts of any value between spouses or registered civil partners

• Annual gifts of up to £3,000 in each tax year

• Regular payments out of your income. Regular payments paid directly out of your income can help stop the value of your estate increasing. There’s no set limit on these payments, but they will only qualify for exemption if you have enough income left to fund your normal lifestyle.

• Wedding gifts or civil partnership ceremony gifts (you can give £5,000 to your children, £2,500 to grandchildren or £1,000 to anyone else).

• Small gifts of up to £250 per person, per year

• Gifts to charities, political parties or national organisations (donations are tax-free during your lifetime, and when you leave money to charity in your will).

Potentially exempt transfers (PETs) - Potentially exempt transfers (PETs) are gifts to individuals (as well as gifts into certain specific types of trusts) which exceed the available exemptions above.

There is no inheritance tax to pay straight away when you make the transfer, but IHT will need to be paid if you die within seven years and the value of the PET puts you over the nil rate band.

Gifts made less than three years before your death incur the full 40% tax charge. Gifts made three to seven years before you die are taxed on a sliding scale known as taper relief.

Assuming you live for more than seven years following the PET, its value wouldn’t be added to your estate when you die. In this case, there would be no inheritance tax to pay on the gift.

A transfer is classed as a chargeable lifetime transfers (CLT) when an individual makes a gift that is not outright, for example, a gift into a flexible or discretionary trust.

There will be no inheritance tax to pay when making a CLT, as long as your total amount of CLTs in the previous seven years is less than the available nil rate band.

If the CLT, when added to the total amount of CLTs in the previous seven years exceeds the nil rate band, there will be a lifetime inheritance tax charge of 20% on the excess amount.

Chargeable lifetime transfers will usually fall outside of your estate for IHT purposes if you survive for at least seven years after the CLT was made. However, if you die within seven years of making the CLT, then its value will be part of your estate.

Any inheritance tax you already paid on a CLT when you were alive will be deducted from any IHT due on it after your death.

Lifetime gifts are often seen as a simple way to reduce inheritance tax, but it’s a complicated matter that needs serious thought.

As well as ensuring you abide by the rules, you’ll need to consider the affordability of giving gifts, without leaving yourself short in your later years.

You’ll also need to think about when you want your beneficiaries to gain access to the assets you gift them. For instance, you may want to give money to your children or grandchildren but retain control over what age they receive it. This can sometimes be done by placing the money into trust.