How to Reduce Inheritance Tax in the UK

Inheritance tax (IHT) is often a concern for families wanting to preserve their assets for the next generation. With careful planning, you can reduce or even eliminate your inheritance tax liability, ensuring that more of your estate passes to your loved ones. In this article, we’ll explain how inheritance tax works, the current thresholds, and the various methods you can use to reduce the amount your estate is taxed.

What is Inheritance Tax?

Inheritance tax is a tax levied on the estate (property, money, and possessions) of someone who has died. In the UK, the current inheritance tax rate is 40% on estates valued above the Inheritance Tax Threshold, also known as the nil-rate band. It’s crucial to note that IHT is only applied to the portion of the estate that exceeds this threshold.

Inheritance tax is a tax levied on the estate of someone who has died. For more information on the current Inheritance Tax rules in the UK, visit the UK Government website.

Understanding the Inheritance Tax Threshold

The inheritance tax threshold currently stands at £325,000. This means that if the value of your estate is less than this amount, no inheritance tax will be owed. However, if your estate exceeds this amount, IHT will be charged at a rate of 40% on the excess.

For example, if your estate is worth £500,000, inheritance tax would be charged on the £175,000 that exceeds the threshold (£500,000 – £325,000), amounting to a tax bill of £70,000 (40% of £175,000).

Residence Nil Rate Band (RNRB)

In addition to the £325,000 threshold, there is the Residence Nil Rate Band (RNRB). This is an additional allowance that applies when you pass on your main residence to your direct descendants, such as children or grandchildren. The RNRB for the 2023-2024 tax year is £175,000. Combined with the standard nil-rate band, this means an individual could potentially leave up to £500,000 without paying any inheritance tax.

For married couples or civil partners, the unused portion of their tax-free allowances can be transferred, meaning that the combined threshold for a couple could reach £1 million (£325,000 + £175,000 per person).

Ways to Reduce Inheritance Tax

Make Use of Gifts
One of the simplest ways to reduce your inheritance tax bill is to give away part of your estate while you’re still alive. Under current rules, you can gift up to £3,000 each year without it being subject to inheritance tax. This is known as the annual exemption. You can also make small gifts of up to £250 per person, as well as wedding or civil partnership gifts of up to £5,000 to children.
Gifts given more than seven years before your death are also exempt from inheritance tax, under the seven-year rule. If you die within seven years of making a gift, it may still be subject to IHT, but at a reduced rate, depending on how many years have passed.

Learn more about gifting and inheritance tax exemptions.

Leave Money to Charity
If you leave 10% or more of your estate to charity, the inheritance tax rate on the rest of your estate can be reduced from 40% to 36%. Not only does this support a good cause, but it also lessens the overall tax burden on your estate.
Set Up a Trust
Trusts can be a useful way to reduce inheritance tax. By transferring assets into a trust, you remove them from your estate, potentially reducing the value of your estate below the IHT threshold. Trusts can be complex, and different types of trusts have different tax implications, so it’s important to seek professional advice when setting one up.
Use Life Insurance
Although life insurance doesn’t directly reduce inheritance tax, it can provide a lump sum that covers the IHT liability on your estate. Many people set up life insurance policies specifically to cover the inheritance tax their estate would owe, ensuring their beneficiaries don’t need to sell off assets to cover the bill. More information regarding the best life insurance for over 60s can be found on this link Best Life Insurance for Over 60s – Later Living Helpline.
Use Business or Agricultural Relief
If you own a business or agricultural property, you may be able to claim Business Property Relief (BPR) or Agricultural Property Relief (APR). These reliefs can reduce the value of your estate that is subject to inheritance tax. In some cases, BPR and APR can reduce the taxable value of assets to zero.

Example of Inheritance Tax Reduction

Let’s consider a couple who own an estate valued at £1.2 million. By utilizing the RNRB and combining their nil-rate bands, they can leave £1 million tax-free (£500,000 each). The remaining £200,000 would be subject to inheritance tax at 40%, resulting in a tax bill of £80,000. However, if they had gifted part of their estate years before, that bill could be further reduced.

Conclusion

Inheritance tax doesn’t have to be an unavoidable burden on your estate. With careful planning, you can take steps to reduce or eliminate the amount owed, ensuring that your loved ones benefit more fully from the assets you’ve worked hard to build. Whether through gifting, using trusts, or making the most of your tax-free allowances, taking action now can make a significant difference later.

If you need assistance with inheritance tax planning or want to explore your options, contact Later Living Helpline today for professional advice and guidance.