The taxman raked in a massive £2.7 billion from inheritance tax between April and August this year, up 35% compared to the same period last year.

This is despite there being plenty of perfectly legal ways to avoid inheritance tax bills – or at least reduce the amount owed.

When Gordon Brown was Chancellor of the Exchequer, he described inheritance tax as a “voluntary tax” because of the various ways you can avoid it, while Roy Jenkins, another former Chancellor, called it “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.”

Here, we look at how inheritance tax works and explore some of the ways you might be able to cut the amount your loved ones will need to hand over to HMRC.

How does inheritance tax work?

Inheritance tax is payable at a rate of 40% on the value of your estate which exceeds £325,000. There is no inheritance tax to pay if your estate is worth less than this £325,000 threshold, which is also known as the nil-rate band.

So, for example, if your estate is worth £425,000, inheritance tax of £40,000 would be payable (40% of the £100,000 in excess of the £325,000 threshold). If your estate is worth £300,000, however, no inheritance tax would be owed, as its value is below the £325,000 nil-rate band.

There’s also an additional allowance of £175,000, known as the main residence nil rate band, which can be used if you’re planning to leave your home to your children or grandchildren. If you don’t have any direct descendants, you won’t qualify for this allowance. You can find out more about how inheritance tax rules work in our article Understanding Inheritance Tax.

Ways to reduce inheritance tax

There are several ways to reduce inheritance tax, outlined below. Bear in mind, however, that estate planning can be complex, and some of these options may not be suitable for you, so you should seek professional financial advice if you’re looking for specific recommendations based on your individual circumstances. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you.

1. Write a will

Making a will is one way to ensure you don’t leave your loved ones with a bigger inheritance tax bill than you need to. Having one in place means that your assets will be distributed to who you want them to go to, and in a way that may help minimise any potential inheritance tax liability.

The good news is that October is Free Wills Month, so if you’re aged 55 or over and you’ve yet to write a will, or you think yours needs updating, you could get a solicitor to help you free of charge. Find out more in our article Get a free will!

If you don’t manage to sort out your will during Free Wills Month, or are looking to get yours done later this year, we have partnered with Farewill, a reputable online provider who have an excellent trustpilot rating. They are offering Rest Less members a 20% discount off the cost of writing your will if you use the code ‘restless20’ at the online checkout. The normal cost of writing a will online (before the discount is applied) with Farewill is £90 for a single will or £140 for a couples will. If you want to make your will over the phone this rises to £120 for a single will, or £190 for couples.

2. Leave a gift to charity

If you make a gift to charity in your will, there won’t be any inheritance tax to pay on it, so you’ll not only be able to help causes close to your heart, but it can also help keep your tax bills down.

If you’re planning to leave a substantial charitable gift, which is equivalent to 10% or more of your estate, this will reduce how much inheritance tax is charged on the remainder of your estate, as it reduces your payable rate from 40% to 36%.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “Legacies are a lifeline for charities, and by leaving money in your will, you won’t just get a warm glow from helping a good cause, you’ll also get a boost from knowing you could cut your inheritance tax bill too. There are just certain steps you need to take to avoid the pitfalls of legacy giving.

“If you leave a fixed sum, your circumstances could change, so it makes up a much more or less significant part of your estate when you die. So, for example, you might have an estate of £200,000 and write a will leaving £10,000 to charity (5%). Then you go into a care home, and spend £150,000 of your estate. Suddenly you’re leaving 20% of your estate to charity. One way to deal with this is to lay out specific bequests to family and leave the remainder to charity. Alternatively, you can specify a specific percentage of your estate goes to the charity.”

3. Take out a life insurance policy written in trust

If you know your estate is worth more than the inheritance tax threshold, you may want to take out a whole of life insurance policy to provide your loved ones with a lump sum to pay your inheritance tax bill when you die. Although this won’t reduce the amount you have to pay, it can mean that they don’t end up with a massive bill to pay from your estate.

You should write your life insurance policy ‘in trust’. By doing this the money that’s paid out by the life insurance policy can be accessed without probate having been granted and it isn’t liable for inheritance tax as it falls outside your estate. This is normally free to do and typically just involves filling in a form. You can find out more about life insurance in our guide What are the different types of life insurance?

Sean McCann, chartered financial planner at NFU Mutual, explained: “Many people buy life insurance without advice, so aren’t aware that if they don’t put the policy in trust it’s included in their estate and could end up being taxed at 40%. Putting life insurance policies into trust is relatively straightforward. If you have life insurance and it isn’t in trust, phone your provider and ask for a trust form.

“Provided you’re in good health when you put it into trust, there are normally no inheritance tax implications, as in most cases the policy has no value. However, if you are seriously ill when you put the policy in trust and die within seven years, HMRC could argue that the policy had a value when you put it into trust and seek to include that value in your estate and charge inheritance tax.

“Using a trust can also mean a speedier pay out in the event of a claim, as the family won’t need to wait for probate, which can make a huge difference to dependants relying on the money to cover day to day bills.”

4. Make gifts during your lifetime

You can give away £3,000 worth of gifts each tax year without them being added to the value of your estate. If you don’t use this annual exemption one year, you can carry it forward to the next tax year.

As well as your £3,000 annual exemption, you can give as many £250 gifts per person as you want during the tax year, provided you haven’t used another exemption on the same person.

If you want to give someone a large lump sum – perhaps you want to help your children with a property deposit, or pay off their student debts for them – it will be exempt from inheritance tax provided you live for a period of seven years after making the gift.

Various other allowances and exemptions apply, so it’s well worth taking advantage of them. Find out more in our guide Which gifts are exempt from Inheritance Tax?

5. Avoid dipping into your pension before you have to

Any money that is left in your pension when you die is normally free of inheritance tax so if you can afford to, it may be a good idea to make it the last thing you spend. As a general rule, other savings and investments are subject to inheritance tax but pensions aren’t.

Dawn Mealing, head of advice policy and development at Fidelity International, said: “Pensions can be a great way to preserve your assets, as they are generally exempt from inheritance tax. If you can, draw income from non-pension assets before taking income from your pension. You can also maximise your income and capital gains tax savings by taking income from individual savings accounts (ISAs), investment bonds (up to 5% per annum) or by encashing capital gains from investment funds up to £12,300 per year per person.”

Find out more in our guide What happens to my pension when I die?

6. Get hitched!

Tying the knot for tax reasons might not sound very romantic, but depending on your circumstances it could substantially reduce your inheritance tax bills. 

If you live with your partner, but aren’t married or in a civil partnership, the inheritance tax rules are much less generous:

  • You each have your personal nil-rate band or inheritance tax allowance (£325,000 in the tax year 2021-2022)

  • You can give money or assets that you own to your partner, but they won’t be automatically exempt from inheritance tax.

If you get married or enter into a civil partnership, then not only can you give away anything to your husband, wife, or civil partner without worrying about inheritance tax, but your inheritance tax allowance can be transferred to them after your death. This effectively gives married couples and those in a civil partnership much more flexibility about who they leave money and property to.

Have you taken any steps to reduce potential inheritance tax bills? If so, we’d be interested in hearing from you. You can join the money conversation on the Rest Less Community forum, or leave a comment below.


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