How to avoid inheritance tax: key considerations and strategies

If you are a high-net-worth individual, you are likely to be aware of the potential burden that inheritance tax can place on your estate and your beneficiaries. Inheritance tax is a complicated subject and one that requires careful consideration when planning your estate. In this article, we review some key strategies that can demonstrate how to avoid inheritance tax and maximise the amount of wealth that your loved ones can receive when you pass away.

What is inheritance tax?

Inheritance tax (IHT) is a levy on the estate of someone who has died. An estate generally consists of property, savings, investments and other assets, from which the value of any debts and funeral expenses can be deducted.

The standard inheritance tax rate is 40%. It is only charged on the part of your estate that exceeds the tax-free threshold (known as the nil-rate band) which is currently £325,000 - and is set to be frozen at this level until April 2028.

Only a small percentage of estates are large enough to incur inheritance tax. However, for estates worth more than £325,000, it is important to understand how to work out what your beneficiaries will need to pay and when, and some of the ways you can reduce a potential IHT liability.

Especially for high-net-worth individuals with an estate worth more than £1 million, it can be crucial to understand the options available to reduce your IHT liability, or how to avoid inheritance tax completely.

In this guide, we cover 14 key considerations and strategies that can help you to minimise or avoid IHT, including fully utilising the available tax-free allowances, gifting your assets and making tax-efficient investments.

How to avoid inheritance tax: 14 key steps

1. Calculate the value of your estate
2. Understand the current IHT rules and thresholds
3. Make a will
4. Make use of the tax-free allowances
5. Spend your money, or give it away, during your lifetime
6. Leave money to a UK charity, sports club or political party
7. Leave your estate to your spouse
8. Put your assets into a trust for your beneficiaries
9. Pay into a pension instead of a savings account
10. Regularly give away up to £3,000 a year in gifts
11. Consider an equity release scheme
12. Take out a life insurance policy
13. Use all property allowances
14. Invest to reduce IHT

Following these steps could help you to reduce your inheritance tax liability and ultimately leave more of your estate to your loved ones.

1. Calculate the value of your estate

When considering how to avoid inheritance tax, the first step is to calculate the value of your estate.

You should include the value of the following assets:

1. Your property
2. Savings
3. Investments
4. Valuable possessions
5. Any other assets

Then subtract the following:

1. Debts
2. Reasonable funeral expenses

You can then use this figure to decide if you need to take further steps to avoid inheritance tax. If your estate is worth more than £325,000 (the current nil-rate band), an inheritance tax bill may be likely.

It is important to keep the value of your estate up to date and review it regularly, as the value of your assets can change over time and could attract an inheritance tax liability in the future.

You can use this inheritance tax calculator to calculate an approximate value of the estate of someone who has passed away, and determine whether inheritance tax is likely to be due.

2. Current IHT rules and thresholds in the UK

Inheritance tax at a rate of 40% may be due on assets you leave to your beneficiaries if the total value of your estate is more than £325,000.

Importantly, additional inheritance tax rules and thresholds exist that can enable individuals to increase - and even double - their tax-free allowances, provided that certain criteria are met.

Passing on your home to loved ones

You can leave your home/s to your spouse or civil partner when you pass away, and there is no IHT to pay, irrespective of the value of the property (this applies to any asset that you leave to your spouse or civil partner).

However, if you leave the home to another person in your will, it counts towards the value of your estate, and IHT may be due on the asset.

The residence nil-rate band (RNRB)

The residence nil-rate band (RNRB) is an additional inheritance tax-free allowance that can apply on the value of a property you own. Currently standing at £175,000, the RNRB is set to be frozen at this level until April 2028.

This additional IHT-free threshold can combine with the standard nil-rate band (£325,000) to potentially increase your overall tax-free allowance to £500,000 - provided that a number of certain criteria are met.

Namely, to qualify for the RNRB, you must have owned and at some point lived in the property, on or after 8 July 2015. Additionally, to qualify, you must leave your home to any of your direct descendants, such as:

• Children
• Grandchildren
• Stepchildren
• Adopted children
• Foster children

Here's an example...

Let's say you've got an estate worth £600,000. You've decided to leave your home to your children and you qualify for the residence nil-rate band. This means no inheritance tax will be charged on the first £500,000 of your estate (£325,000 basic allowance + £175,000 main residence allowance). There will be a 40% charge on the remaining £100,000, making a total of £40,000 due in inheritance tax (presuming you're not leaving anything to charity).

If you weren't leaving your home to your direct descendants, you'd pay no IHT on the first £325,000 of your estate, and 40% on the remaining £275,000, meaning a total of £110,000 to pay in inheritance tax.

You can find out more about the residence nil rate band here.

Taper relief

It is important to note that there is tapered withdrawal of the RNRB if the overall value of your estate exceeds £2 million.

For every £2 that your estate is above £2 million, the residence nil-rate band decreases by £1. So, if the total value of your estate reaches £2,350,000, you are unable to benefit from the RNRB at all.

If you are interested to learn more about how the RNRB taper relief system works, you can find out more about tapered withdrawal here.

3. Make a will

In order to reduce a potential IHT liability and maximise tax efficiency, it can be useful to make a will. By making a will, you can ensure that your estate is distributed according to your wishes, and that you can pass on as much of your wealth as possible to your loved ones.

It is important to keep your will up to date as your financial situation changes. This is because you may need to modify your will in order to ensure that your wishes are still properly represented. Ultimately, by keeping your will current, you could help to reduce the amount of inheritance tax due on your estate and ensure your loved ones receive certain assets as intended.

4. Make use of the tax-free allowance (currently £325,000 in the UK)

In the 2022/23 tax year, no inheritance tax is due on the first £325,000 of an estate, but 40% IHT is normally charged on any amount exceeding this figure.

Importantly, if you leave your entire estate to your surviving spouse or civil partner, your nil-rate band would remain entirely unused. As a result, the nil-rate band can be transferred to your surviving spouse or civil partner, doubling their tax free allowance from £325,000 to £650,000.

In addition, the same process can apply with the residence nil-rate band. If the £175,000 RNRB is unused, you can transfer this to your spouse or civil partner and double their overall RNRB to £350,000. Although it should be noted that the RNRB transfer can only be fully utilised if the property in question is worth £350,000 or more.

5. Spend your money, or give it away, during your lifetime

No inheritance tax is due on any gifts you give, as long as you live for seven years after giving them. By spending your money or giving it away during your lifetime, you could reduce the value of your estate and subsequently reduce the amount of any inheritance tax due when you pass away.

You should also carefully plan how you structure your assets, as this could also help you to reduce the amount of inheritance tax due. For instance, passing on money to your spouse or civil partner, or setting up trusts, may mean that less of your estate is likely to be subject to IHT. 

You should also ensure that you keep accurate records of all gifts made so that HMRC can check that the right amount of tax is paid. Making a gift to your family and friends while you’re alive can be a good way to reduce the value of your estate for inheritance tax purposes and benefit your loved ones immediately. But estate and tax planning is a complex area, so getting professional advice can help you avoid common mistakes when making a gift.

6. Leave money to a UK charity, amateur sports club or political party

You may also consider leaving part or all of your estate to a UK charity, Community Amateur Sports Club (CASC), or political party in your will. If you leave 10% or more of your taxable estate to one of these groups in your will, the inheritance tax rate for the rest of your estate could fall from 40% to 36%.

This means, in some scenarios, donating to charity could actually lower the amount of tax that HMRC receives from your estate, whilst your loved ones can also still receive the vast majority of your estate. However, the outcome depends on how much your estate is worth in the first place, as well as the size of your charitable donation. Always seek advice before gifting to charity in relation to estate planning.

7. Leave your estate to your spouse

Your spouse or civil partner will never have to pay inheritance tax on assets you leave them, regardless of the value. Making the most of this in your will can reduce, or completely eliminate, any IHT due on your estate.

If you’re part of a married couple or civil partnership, you can not only benefit from the main transferrable tax-free allowance but also from the transferrable main residence allowance. This means that any person who is part of a married couple or civil partnership could leave more than their sole £325,000 tax-free allowance to their partner, completely free of IHT.

If you are part of a married couple planning your wills jointly, and own your family home together, you could leave the property to your direct descendants and potentially benefit from a total residence nil-rate band of £350,000.

Furthermore, this could be combined with the total transferrable main nil-rate band (£650,000) and potentially create a total inheritance tax-free allowance of as much as £1 million before beneficiaries have to pay IHT to HMRC.

Please note that when this allowance gets transferred between partners, its value will rely on the value in place when the second partner passes away - not the figure in place at the time of the first death.

8. Set up a trust to avoid inheritance tax

Cash, investments or property held in a trust sit outside of your estate for inheritance tax purposes, and can therefore help you avoid an inheritance tax bill. You may want to set up a trust for your children, grandchildren, or other family members. Trusts can help you manage who will receive your assets after you pass away, as well as how and when they will receive them.

If you put assets into a trust, provided certain conditions are met, they no longer belong to you. This means that, when you die, their value normally won’t be included when the value of your estate is calculated. Instead, the cash, investments or property belong to the trust. In other words, when assets are held in trust, they are outside of anyone’s estate for inheritance tax purposes.

Another potential advantage of holding assets within a trust is that this route is a way of retaining control and asset protection for the beneficiary. A trust avoids handing over valuable property, cash or investments while the beneficiaries are relatively young or vulnerable. The trustees have a legal duty to look after and manage the trust assets for the person who will eventually benefit from the trust. When you set up a trust, you decide the rules about how it’s managed. For example, you could say that your children will only get access to their trust when they turn 18.

You can find out more on how to avoid inheritance tax by setting up a trust here.

9. Pay into a pension instead of a savings account

Depending on the type of pension, wealth could be passed on to your dependents or family members tax-efficiently. Contributions to your own pension scheme are not usually lifetime transfers of value. However, if the contributions are made while the member is in good health, there will be no transfer of value. But if made while the member is in ill health, there may be a transfer of value.

If we assume that there is no transfer of value, there can be a benefit to making pension contributions to your own pension for others to benefit from and save IHT. But the question as to whether or not this would make your estate more valuable for beneficiaries depends on a number variables:

• What amount of IHT would actually be saved (factoring in the tax relief that the member gets)?
• Would there be any matching from an employer?
• Will the member qualify for tax relief?
• When is the member likely to die (which can affect the tax position of the death benefits)?
• What tax rates would apply to any beneficiaries?
• Will there be an annual allowance excess?
• Will there be a lifetime allowance excess?
• How will death benefits be paid based on the scheme rules?

10. Regularly give away up to £3,000 a year in gifts

You can gift up to £3,000 per tax year, immediately free of inheritance tax, and this is known as the 'annual exemption'. Any unused annual exemption can be carried forward for one tax year only.

This means you can give away assets, usually worth up to £3,000 per tax year, without being added to the value of your estate for inheritance tax purposes.

Any part of the annual exemption which isn’t used in the tax year can be carried forward to the following tax year, potentially creating a tax-free gifting allowance of £6,000 in one tax year. The annual exemption can only be used in the following tax year and can’t be carried over any further.

Furthermore, certain gifts, such as maintenance gifts and wedding gifts (under certain amounts) don’t count towards this annual exemption. As such, no inheritance tax is due on them.

Importantly, gifts worth more than the £3,000 allowance in any tax year might be subject to inheritance tax, unless you live for seven years after giving the gift.

Gifts worth less than £250

You can give as many small gifts of up to £250 to as many different individuals as you wish within one tax year. Although, not to anyone who has already received a gift making use of your £3,000 annual exemption. None of these small gifts are subject to inheritance tax.

11. Consider an equity release scheme

If all your wealth is tied up in your property, you may not be able to make use of gifts during your lifetime or spend your wealth on yourself. To get around this, some people take out an equity release scheme.

An equity release scheme is a way of unlocking the cash in your property without having to sell it. You can take out a loan against the value of your home and use it to pay off any debts or make other purchases. The loan is repaid with interest when the house is sold. This means that you can use the money that is tied up in your home, potentially helping to minimise any inheritance tax due.

Ultimately, by using an equity release scheme, you can avoid inheritance tax and still make use of the money tied up in your property.

12. Take out a life insurance policy

If you can't reduce an IHT bill, you can insure against it. Life insurance is one of the simplest ways of covering an unwelcome bill, but unless you're relatively young and healthy, policies can be expensive.

The amount of life insurance you may need is based on the size of the potential inheritance tax bill your beneficiaries might face.

If you have an estate valued at more than the IHT threshold, you could consider taking out a life insurance policy to cover the expected IHT bill. It's important to remember that the proceeds of a life insurance policy are normally paid out tax-free, so it's possible to cover the entire IHT bill with a single policy.

However, it is also important to remember that life insurance premiums can be expensive, so you should always consider a number of options to find the best deal.

13. Utilise property allowances

If you leave your home to your children or grandchildren in your will, then inheritance tax-free property allowances could increase your IHT-free threshold by £175,000 (potentially taking the total IHT-free allowance for an individual to £500,000).

For a married couple who combine their allowances and leave their home to children or grandchildren, an estate of up to £1 million could be passed on to loved ones, completely free of IHT.

Any transfer of assets between married couples and civil partners are not subject to inheritance tax, so if the first partner to pass away leaves their entire estate to the other, no tax will be payable.

In this case, it is likely that the deceased person won't have used up any of their nil-rate band, so the surviving partner can add the unused balance to their own, effectively doubling the threshold.

However, if your partner has left bequests to others (and lifetime gifts made within seven years of their death), their estate may attract IHT - if it exceeds £325,000 - and may use up some or all of their nil-rate band.

14. Invest to reduce inheritance tax

For those with an estate that is likely to be worth over £1 million at the time of their passing, it could be useful to consider investments that allow your wealth to be passed on to your loved ones, free of inheritance tax. Such investments can include investing in BPR-qualifying companies, AIM ISAs, and EIS- and SEIS-qualifying businesses. These types of investments could potentially increase the value of your estate without attracting any additional IHT liability.

EIS and SEIS investments

Investments made into an Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) qualifying unquoted company or AIM stock will not be liable to inheritance tax after being held for at least two years under the Business Property Relief (BPR) rules.

The clock runs from the time the investment was made. After two years, the value and growth on the investment shares fall out of your estate for IHT purposes. The EIS or SEIS investment can be replaced with another EIS or SEIS investment within certain time limits, and the BPR clock continues to run. 

As well as offering inheritance tax relief on the value of shares, EIS and SEIS investments can also offer 30% and 50% income tax relief, respectively, capital gains tax exemption, and loss relief (should a loss be incurred on the investment). Furthermore, recent changes to the SEIS provide investors with the potential to receive greater benefit from the scheme and shield double the amount of capital than previously allowed from inheritance tax.

Importantly, EIS and SEIS investments are considered as being higher-risk strategies and are therefore more suitable for high-net-worth individuals and sophisticated investors. It should also be noted that any dividends payable are taxable, and any losses on shares are generally deductible from income tax or capital gains tax bills.

ISAs holding BPR-qualifying shares

Previously, ISA investments would be subject to IHT upon the passing of the ISA holder, as they could not previously include shares that qualified for Business Property Relief.

However, from 5 August 2013, ISAs can now include shares quoted on the Alternative Investment Market (AIM), some of which qualify for BPR and, in some cases, the Enterprise Investment Scheme.

The current maximum ISA investment is £20,000 per annum, and so this could prove an effective method for investors to allocate capital to this tax-efficient scheme and, after two years, qualify for IHT exemption on the value of their ISA.

Practical Inheritance Tax Tip:

If the objective is to save IHT, analyse all investments and determine which ones can be sheltered from IHT. You could save thousands of pounds. Independent financial advice should be obtained on the investment where necessary. Professional advice should also be sought on the IHT implications.

A guide to inheritance tax

Inheritance tax can significantly reduce the value of any assets left to your loved ones upon your passing. It can be an unnecessary additional burden at an already difficult time. However, the steps outlined above can help with reducing your IHT liability and, in some cases, avoid inheritance tax altogether.

Three of the main steps include making use of IHT-free thresholds and gifting allowances, setting up trusts, and making tax-efficient investments. By understanding the inheritance tax rules and taking proactive steps to protect your assets, you can help to ensure that your beneficiaries receive as much of your wealth as possible.

Inheritance tax is a complicated subject to understand, so it may be beneficial to consult a professional financial advisor or lawyer who can help you navigate the process and explain how to avoid inheritance tax and ensure you are making the best decisions for your estate.

Additionally, doing research online and talking to others who have experienced the process of dealing with inheritance tax could help you gain a better understanding of the rules and regulations involved. For example, GCV's free guide to inheritance tax could prove a useful resource to consult when researching the options available to reduce any IHT potentially due on your estate.

By taking the time to understand the implications of inheritance tax and planning for it, you can help to ensure that your loved ones receive the full distributions of your hard-earned wealth.