How to avoid inheritance tax

How to avoid inheritance tax

To make sure we always provide you up-to-date information, this page was last reviewed on 1 September 2020

How to avoid inheritance tax

Inheritance tax is a tax that is paid to the government on an estate after a person dies.

If you are planning how you will pass on your estate, you may be beginning to think about how to avoid inheritance tax in order to make sure your children and loved ones benefit from as much of your estate as possible.

Topics that you will find covered on this page

You can listen an audio recording of this page if you prefer.


What is inheritance tax?

This is a tax charge you have to pay to the government on any part of your net worth that is over your personal allowance, also called the nil-rate band.

When the inheritance tax bill is payable depends on the form of your estate, and whether you set up trusts, hence why tax planning is so important.

How much can you inherit without paying inheritance tax?

As a guide, you can pass on your estate free from tax if it worth less than £325,000, plus an additional £175,000 if you are passing on your main residence to your direct descendants. 

You will not have to pay tax on inheritance if you are the person’s spouse or civil partner.

Here is a short video explaining how inheritance tax works.

What is the nil-rate band/personal allowance?

The nil-rate band is the amount of money you can leave to family and loved ones free from tax. Currently, IHT is payable where you leave an estate with a value of over £325,000.

How is inheritance tax calculated?

Calculating the tax bill involves adding up everything the deceased person owned or was owed, including by their insurance policy, then deducting all their debts.

Then, the IHT allowance is deducted, including if the person has received their spouse or partner’s unused allowance and any additional residential allowance. Then any gifts made in the last seven years are considered.

What counts as part of my estate?

Your estate is all of your assets, including your home, money in the bank, and any money payable from insurance policies. You can deduct from your estate any money you owe to a person or a bank. Your whole estate has the potential to attract tax liability.

When do I not need to pay inheritance tax?

You do not need to pay inheritance tax in two main situations:

  • Where your estate is worth less than the £325,000 threshold
  • Where you leave everything above the nil-rate band to your spouse, civil partner, a charity, some political parties or a community sports club

When do I have to report an inheritance to HMRC?

Even if your estate is worth less than the threshold, and therefore you think it will not be subject to tax you still should make sure to report it to HMRC.

How much is inheritance tax?

The current rate of inheritance tax is 40% of the value of your estate over the nil rate band or personal allowance. However, the inheritance tax charge is reduced to 36% if you are donating over 10% of your estate to charity in your will.

What is the threshold for inheritance tax?

The law may change,  but this is currently £325,000. However, if one spouse does not use their allowance, this can be transferred to their partner after their death.

What is the threshold if I am leaving my estate to my direct descendants?

If you are passing on your home to your direct descendants, including your children, adopted children, stepchildren, and foster children, your threshold can be up to £500,000. 

Therefore, if you are married or in a civil partnership, and your estate is under the threshold value when the unused threshold is passed onto your partner when they pass away their threshold can be up to a million.

"The current rate of inheritance tax is 40% of the value of your estate over the nil rate band or personal allowance. However, the inheritance tax charge is reduced to 36% if you are donating over 10% of your estate to charity in your will."

How much is the residence nil rate band?

There is a further higher threshold for when you leave your family home to your descendants, which is currently £175,000 and can be transferred between spouses and civil partners.

This only applies when passing on your main residence to direct descendants.

There is taper relief, so for estates worth over £2 million, your inheritance tax to pay is reduced by £1 for every additional £2.

Who is eligible for the residence nil rate band?

You will have a higher tax-free allowance when you leave your family home to:

  • Children
  • Adopted, foster or stepchildren
  • Grandchildren or their civil partners or spouses
  • Children in your guardianship
avoiding inheritance tax

How to avoid inheritance tax on property:

There are a number of  ways to avoid inheritance tax on property, and therefore improve the amount your family and loved ones can inherit, including:

  • If you leave over 10% of your estate to charity this reduces your inheritance tax rate to 36%
  • Pay money into a pension, not a savings account
  • If you leave your estate to your spouse or civil partner
  • Make tax-free gifts of up to £3000, or making gifts over seven years before you die
  • Maximise your personal allowance, which is free from tax
  • Equity release
  • Using a life insurance policy that will pay your inheritance tax

Who pays inheritance tax?

Inheritance tax is generally paid by the executor of the deceased person’s estate. They will pay HMRC out of funds from your estate.

Do beneficiaries of an estate pay inheritance tax?

Beneficiaries do not usually pay taxes on inheritance, as the tax is paid from the estate before they inherit it. However, they may be subject to other taxes, such as if they get income from a property they inherit.

If I give someone a gift, do they have to pay inheritance tax?

People you have made gifts to may have tax to pay but only if you gave away over £325,000 and you died within seven years of making the gift. There are rules on the amount you are allowed to give away at once.

How can I make tax-free gifts?

Each tax year you can make a gift of up to £3000 free from tax, between however many people you want. You can also make unlimited gifts of up to £250.

Do I pay inheritance tax on wedding gifts?

Different rules apply to wedding gifts. You can make wedding gifts of up to £1000, increased to £2500 for your grandchildren and £5000 for your children.

You have to have made the gift before the wedding and the wedding must have actually happened, otherwise, the gift will be treated like a potentially exempt transfer, so will only be free from tax if you are still alive after seven years.

What is a potentially exempt transfer?

A potentially exempt transfer is when you make a gift during your lifetime, but you do not know if you will have to pay an inheritance tax bill on it until seven years have passed.

You are only eligible for the exemption if you have given away less than £325,000 worth of money and assets in the seven-year period before your death.

What is the 7 year rule in inheritance tax?

The seven-year rule is that if you give away money or assets over seven years before you die, then this sum will be free from inheritance tax. Many people will use this as a method of reducing inheritance tax by giving money to their children and family during their lifetime.

How much tax is payable on gifts made within 7 years of death?

You may still reduce inheritance tax by making a gift of assets or money within seven years of your death. There is a taper or sliding scale determining the tax rate, therefore the tax bill is higher the closer the gift was made to the person’s death.

What is the annual exemption?

You can give away up to £3000 per tax year without having to pay tax. These gifts are outside your estate,  therefore you are avoiding iht. You can carry your exemption over to the next year, but only for up to one year.

Do I have to pay tax on money I give to my spouse?

Giving away money to your spouse or civil partner is free from inheritance tax.

How to avoid inheritance tax with a trust?

If you put your money, property, home, or assets into a trust, in most cases they will be outside your estate for tax purposes.  

Setting up a trust fund to avoid inheritance tax can be created during your lifetime or in your will. 

You will need to get help from legal services to set up a trust, otherwise, there can be unintentional capital gains tax or inheritance tax consequences.

Can you put your house in trust to avoid inheritance tax?

You can put your home into an asset protection trust or life interest trust so that the property is no longer part of your estate, and therefore your estate may come below the inheritance tax threshold.

However, this can be complicated, and in some cases will increase the tax may be increased rather than reduced. Therefore legal help is important so as not to fall foul of the tax rules.

Can I use discounted gift trusts to avoid inheritance tax liability?

Discounted gift trusts allow you to make gifts money to a trust, and get income from the trust. The trust purchases an investment bond, and the investment generates an income.

The trust means that assets in the trust do not count as part of your estate, which may reduce the iht bill.

How does the seven-year rule apply to discounted gift trusts?

If you do not die within seven years, the bond is still outside of your estate. If you do die within seven years, the iht bill will still be reduced, because the owner’s right to get income from the trust reduces the assets’ value.

What are the reliefs and exemptions from inheritance tax?

There may be taper relief if you gave the gift within seven years of your death, so the iht rate will be less than 40%. 

There is also business relief and agricultural relief for certain kinds of assets. If this applies to you you should seek legal advice. 

Can equity release reduce how much inheritance tax I have to pay?

One of the inheritance tax planning options is equity release, which is a solution for people who have a lot of wealth tied up in their property, and want to benefit from this wealth now.

However, all equity release means is that you own fewer assets, so there will be more debt that your estate has to pay. Therefore unless you need the money, it is better to make gifts to your children or grandchildren during your lifetime.  

What other taxes are relevant to an inheritance?

Beyond avoiding inheritance tax, you can also consider how you can reduce other taxes your beneficiaries may also have to pay:

  • Income tax if they inherit something that produces an income
  • Capital Gains Tax if they may a profit off selling something they inherited
  • There can be complicated tax consequences if you have put a property in a trust, and therefore you should seek legal advice.

Can I use my pension to reduce potential inheritance tax?

If you are younger than 75 when you die, benefits that are in a money purchase pensions can be paid directly to a beneficiary without having to pay tax. After 75, the tax rate will be the same as the beneficiaries’ marginal income tax rate.

Therefore, if you can rely on other savings during your retirement, rather than your pensions this can reduce the rate of tax on your beneficiaries’ total inheritance.

How can I use a life insurance policy to deal with inheritance tax?

As a guide, life insurance policy is likely to be expensive unless you are young and healthy, but it will cover your inheritance tax bill. As long as the policy is in the form of a trust, the payout won’t be considered part of your estate.

How do I work out what is the best way to reduce potential inheritance tax for my estate?

Estate planning can be complex, so it is often a good idea to get financial advice to support you in choosing the right option for your assets. You also will need to use a solicitor’s services in order to set up any trusts.

How do I choose the right business to advise me on avoiding inheritance tax?

Financial services can help guide you step by step through handling your estate. 

You may want to use a business that you consistently use and trust for your financial affairs. You should choose a financial adviser who is authorised and regulated by the financial conduct authority.

More Articles On Estate Planning & How To Avoid Paying Inheritance Tax

Estate Planning

Estate planning involves considering what to do with a person’s money and assets after they are deceased.

Inheritance Protection Trusts

Trusts are useful for safeguarding your assets so you can pass on as much as possible to your family and loved ones in the form of inheritance.

Gifting Money To Avoid Tax

Making cash gifts to family and children can be an important element of estate planning. That is why you need to know what you can and can’t do.

Inheritance Tax Planning Trusts

Inheritance tax planning is an important part of estate management. These trusts are a great way to protect your assets from inheritance tax.

Avoiding Inheritance Tax

Inheritance tax is a tax that is paid to the government on an estate after a person dies. However, you can legally reduce what you pay.

Property Protection Trusts

This is a trust you put in your will so that the surviving spouse can continue living in your property, but the deceased’s share is separate.

Share on facebook
Share on twitter
Share on email
Share on linkedin