The gift of giving: four ways to reduce your inheritance tax bill

What is inheritance tax?

Inheritance tax (IHT) is a tax that is applied to a person’s estate upon death. Your taxable estate is made up of all your assets, including: any property or business you own, your investments, money in the bank, any pay-outs from life insurance policies, and your possessions. A 40% IHT is applied to estates worth over £325,000 (the current nil-rate band). It is only charged on the part of your estate that is above this threshold.

Two years ago, a new ‘residence nil-rate band’ (RNRB) allowance was also introduced. For the 2019/20 tax year, the maximum RNRB allowance is £150,000. This could increase your total IHT allowance from £325,000 to £475,000. For more information on how to claim this additional allowance, read our blog on the residence nil-rate band here.

The most recent available figures from HMRC suggest around 1 in 20 estates left on death in the UK were liable to IHT. For people with a large estate, IHT can be a real concern.

If you are worried about IHT, here are some legitimate ways that you can reduce the amount of inheritance tax you may have to pay:

• Make a will

This is perhaps the most important step to take. Dying intestate, or dying without a will, means that you may not be making the most of the IHT exemption that exists if you wish your estate to pass to your spouse or registered civil partner. Without a will, other relatives may be entitled to a share of your estate, and this might trigger an IHT liability.

• Make lifetime gifts

Gifts made more than seven years before the donor dies, to an individual or to a bare trust, are free of IHT. This is called a ‘Potentially Exempt Transfer’ (PET). If you live for seven years after making such a gift, then it will be exempt from IHT. If not, it will still be counted as part of your estate if it is above the annual £3,000 gift allowance.  However, the longer you survive after making the gift (subject to surviving at least three years), the lower the IHT charge will be.

You need to be careful if you are giving away your home to your children with conditions attached to it, or if you give it away but continue to benefit from it. This is known as a ‘Gift with Reservation of Benefit’. Under section 102 of the Finance Act 1986, IHT is required to be paid on such gifts as though they remain in the donor’s estate.

• Leave a proportion to charity

Being generous to your favourite charity can reduce your tax bill. If you leave at least 10% of your estate to charity, then your IHT liability on the taxable portion of the estate is reduced to 36% rather than 40%.

• Set up a trust

Putting assets in a trust – rather than making a direct gift to a beneficiary – can be a more flexible way of achieving your objectives.

Certain types of trusts can be useful as a way of reducing IHT, making provisions for your children and spouse, and potentially protecting family businesses. When you put things into a trust, provided certain conditions are met, they no longer belong to you. This means that after your death, they won’t be counted when your IHT bill is worked out. Trusts enable the donor to control who benefits (the beneficiaries) and under what circumstances, sometimes long after the donor’s death.

Compare this with making a direct gift (for example, to a child), which offers no control to the donor once given. When you set up a trust, it is a legal arrangement. You will need to appoint ‘trustees’ who are responsible for holding and managing the assets. Trustees have a responsibility to manage the trust on behalf of and in the best interest of the beneficiaries, in accordance with the trust terms. The terms will be set out in a legal document called ‘the trust deed’.

Get in touch

The right tax planning solutions for you will depend on your personal circumstances. Our independent financial advisers can work with you to discover what these are and how best to move forwards.