How to minimise inheritance tax using tax efficient investments

Following years of rising house prices and further speculation surrounding potential upcoming tax rises, identifying the investments best-angled to minimise inheritance tax has become a growing priority for the UK's experienced investors.

With the average UK house price rising by over 70% for the past decade (from £169,544 in September 2011 to £287,924 in June 2024) more Brits than ever are now liable to pay the current 40% inheritance tax rate.

With rising property values and frozen tax-free inheritance tax thresholds, forecasts now predict that UK inheritance tax receipts could continue to increase significantly, following a £1.5 billion rise during the 2023/24 period, with further growth anticipated in 2024/25.

Compounded by widespread suggestions that a hike in the current rate of inheritance tax is “still very possible” over the coming years, this concern has emphasised the need for investors to identify alternative routes for minimising inheritance tax liabilities before an increasing proportion of their assets are gradually eroded.

When are you liable for inheritance tax?

Though often not the most pleasant tax category to navigate, learning how inheritance tax works - and subsequently how to mitigate it - can best ensure the majority of your hard-earned assets are retained and transferred as intended.

And while it can prove extremely valuable for investors to learn more on the nature of tax efficiencies, it is important to note that the following is not tax advice, but rather educational content to help investors make their own informed decisions. A tax professional should always be consulted before committing to any serious investment.

Inheritance tax (IHT) is a tax that is paid relative to the value of assets an individual leaves behind when they die (otherwise known as their ‘estate’).

A person’s estate can include their home(s), personal possessions, savings, investments and almost any other personal assets they may own. Even gifts given by a person in the seven years up to their death can be liable for inheritance tax.

If you are married or have a civil partner, then you can pass on the full sum of your estate to your spouse free of inheritance tax, but if you wish to leave some or all of it to family and friends (as is often the case) then you will be expected to pay 40% IHT on your estate.

This 40% inheritance tax rate applies on all inheritances worth more than £325,000. Otherwise known as the ‘nil-rate band’, any inheritance below that value is inheritance tax-free.

In addition to this, the government announced that in 2021 individuals can make use of an added £175,000 IHT-free ‘main residence transferable allowance’, increasing the IHT threshold to £500,000 should at least £175,000 of the estate come from a first home.

For example, should your estate be worth £800,000 and is made up of at least £175,000 of the value of your main residence, you would be due to pay £120,000 in inheritance tax (£800k minus the £500k threshold, with the remaining £300k then taxed at 40%).

If you would like to calculate this for your financial situation, using an inheritance tax calculator can be a useful exercise. 

Minimising your inheritance tax bill

Though mitigating inheritance tax is no longer a consideration reserved exclusively for the ultra-wealthy (as rising house prices drive up average estate values), high net-worth individuals do have the potential to benefit, especially from exploring tax-efficient routes.

With a person who, for example, passes on an estate worth £5m, currently being liable to pay £1.8m in inheritance tax, it comes as no surprise that so many individuals possessing particularly considerable inheritances are keen to explore alternative options for shielding their assets.

A number of techniques exist for individuals looking to minimise or even avoid inheritance tax deductions entirely,  ranging from “gifting” sums of money to potential inheritors to - often for more substantial inheritances - forming trusts.

And whilst these are all effective pathways to managing inheritance tax, they can often either be particularly limiting (the annual gifting allowance set at £3,000 within the seven years leading up to death) or conversely can require complicated processes (such as setting up inheritance funds).

Consequently, an increasingly popular method adopted to limit inheritance tax liability - used by experienced investors especially - has been to invest capital either via tax efficient investment schemes that provide inheritance tax exemption (or in some cases via investments made through an individual’s pension).

Such schemes allow investors to pass on considerable values of shares inheritance tax free, and follow often straightforward processes that require little to no upkeep. In the UK, the two schemes that have gained a name more than any for offering such benefits, are the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).

Inheritance tax relief with the EIS and SEIS

Government led venture capital schemes that facilitate private investment into early stage companies, the EIS and SEIS have become increasingly popular in the UK over the course of the last two and a half decades (having raised a combined of total of over £25bn since 1994), in part due to the particularly generous tax reliefs they offer investors.

Among the pair's library of tax advantages (which vary slightly due to the SEIS’s focus on very early stage startups that can present greater investor risk, thus offering more generous tax reliefs), inheritance tax relief stands out as one of the most effective for shielding capital, and yet is one many investors often aren’t aware of.

With both the EIS and SEIS, investors can benefit from full inheritance tax exemption, meaning the entire value of their shares can be passed on without any IHT estate deductions (providing they have been held for at least two years).

Not only does this two-year holding period amount to much less than the minimum seven years present with many other inheritance planning tools, but the EIS’s maximum investment amount of £1m (£2m for knowledge intensive companies [KICs]) makes it especially attractive to high-net-worth individuals with potentially significant estates.

In addition to this, another feature of the schemes that can make them so attractive to experienced investors is that - unlike with trusts whereby an individual must hand over immediate control of funds to their beneficiaries - EIS and SEIS shares are retained under direct ownership of the investor for the remainder of their life.

This means that both schemes not only give inheritance planners the ability to shield thousands and even millions of pounds of their hard-earned assets from growing inheritance tax deductions, but make doing so highly accessible, easy to manage and do so with full independent control.

Just one of the EIS and SEIS’s many tax advantages, IHT when paired with the schemes’ remaining tax reliefs (from 50% income tax relief to capital gains tax relief), high growth potential (targeting promising early-stage SMEs) and ability to drive positive social impact (via transformative KIC startups), the EIS and SEIS can play a pivotal role in investment portfolios angled towards long term growth and generational wealth.

Creating a future plan

As it appears inevitable that an increasing number of individuals across the UK will be forced to consider inheritance tax strategies over the coming years, and somewhat likely that changes to inheritance tax could strip even more assets from those already set to pay high fees, consideration across inheritance tax planning has never been so crucial.

Where it’s vital that you explore all of your available options when creating an inheritance tax plan, and use a combination of approaches best suited to your personal situation and future wishes, considering incorporating inheritance tax investments, for many, will no doubt prove a worthwhile task.

And whilst it pays to remember that schemes such as the EIS and SEIS are still attached with some of the risks commonly associated with venture capital investments, the schemes’ armoury of tax reliefs do work cohesively to minimise them, and in a record-breaking period for UK startup investment, offer the opportunity for more investors to benefit from even greater potential returns, as well as the protection from burdensome inheritance taxes that they seek.