How to Navigate Inheritance Tax Planning: What You Should Know
Inheritance Tax (IHT) is often described as a voluntary tax, not because it isn’t compulsory, but because so much liability can be mitigated with proper planning. Yet, despite this, HMRC collected £7.5 billion in IHT receipts in 2023/24, up from £2.22 billion in 2000/01, according to Statista and HMRC. It’s not just the very wealthy who are affected. Rising house prices, frozen tax thresholds, and changes to pension and business reliefs mean more families than ever could face a significant tax bill.
The origins of inheritance tax in the UK can be traced back to probate duty in 1694, evolving into estate duty in 1894, and finally becoming Inheritance Tax in 1986. Unlike most countries in the OECD, where tax is often levied on the beneficiary depending on their relationship to the deceased, the UK applies a flat 40% rate on the estate's value above certain thresholds. A 2022 report from the US-based Tax Foundation ranked the UK as having the fourth-highest inheritance tax rate globally.
This article doesn’t aim to debate the fairness of IHT, but instead explores practical strategies that can help reduce or even eliminate the potential tax burden on your estate.
Why Inheritance Tax Planning Matters
While Inheritance Tax only applies to a minority of estates today (around 4% of deaths, per HMRC 2023/24), that number is expected to rise steadily due to frozen allowances and asset growth.
The nil-rate band (£325,000) and residence nil-rate band (£175,000) have been frozen until at least April 2028. Meanwhile, average UK house prices have risen from £132,000 in 2000 to over £280,000 in 2024, according to the Office for National Statistics (ONS). In parts of London and the South East, family homes can easily push a couple’s estate over the £1 million threshold.
Families may have to sell assets, including the family home, without adequate planning, to cover an unexpected tax bill. With potential changes to pension death benefits in 2027, even your retirement savings may no longer escape the IHT net.
Understanding the Basics of Inheritance Tax
Inheritance Tax is a charge on your estate when you die. The estate includes all your property, possessions, investments, and certain gifts made during your lifetime. Understanding how the rules work is the first step to planning effectively.
Key Elements of Inheritance Tax:
Nil-Rate Band (NRB):
Every individual has a tax-free threshold of £325,000. Anything above this is potentially taxed at 40%.
Residence Nil-Rate Band (RNRB):
An additional £175,000 allowance is available if you pass your main residence to a direct descendant (e.g. a child or grandchild). For couples, unused allowances are transferable, meaning up to £1 million can potentially be passed on tax-free.
Gifts Within 7 Years:
Gifts made within seven years of death may be taxed using taper relief. Some gifts, such as the £3,000 annual exemption, wedding gifts, and normal gifts out of income, are immediately exempt.
Assets Included in the Estate:
Your estate includes your:
Home and other property
Savings and investments
Pensions (depending on how they are structured)
Life insurance (unless written in trust)
Business or agricultural assets
Gifts made within seven years
Who Pays the Tax?
In most cases, the executor of your estate is responsible for settling any IHT before distributing assets. However, if gifts are made during life and caught by IHT, the recipient may be liable if the estate cannot cover the tax.
Key Inheritance Tax Planning Strategies
Proactive planning can dramatically reduce or even eliminate your IHT liability. The earlier you begin, the more options you have.
1. Use Your Gift Allowances
You can give away up to £3,000 each tax year without triggering IHT (and carry forward unused allowance from the previous year). Small gifts of up to £250 per person, per tax year, are also exempt. Larger gifts may be free of IHT if you survive seven years after giving them.
TIP: Regular gifts made from surplus income (that don’t affect your standard of living) can be completely exempt – a little-known but powerful relief.
2. Consider Trusts
Trusts can be used to pass wealth on to future generations while retaining a level of control. They may remove the value from your estate for IHT purposes, though care must be taken around relevant property charges and ten-year anniversaries. Legal and financial advice is crucial.
3. Put Life Insurance in Trust
A life insurance policy written in trust is not part of your estate and can be paid out immediately to cover IHT liabilities, without waiting for probate. This can provide valuable liquidity to your heirs at a difficult time.
4. Make Use of Business Relief and Agricultural Relief
Certain business and farming assets qualify for up to 100% IHT relief. This can be a game-changer for family-owned enterprises or rural estates. However, the rules are complex, and planned changes to business relief could affect eligibility, so regular reviews are important.
5. Keep Your Will Updated
A properly drafted and up-to-date document will ensure your estate is passed on in line with your wishes and in the most tax-efficient way. It can also help avoid delays, disputes, and unexpected tax charges.
According to Royal London, over 54% of UK adults don’t have a will, and many are out of date for those who do.
6. Plan for Pension Changes
Most pensions fall outside the estate for IHT purposes, especially if passed on before age 75. However, the abolition of the Lifetime Allowance in April 2024 and the potential introduction of income tax on death benefits from 2026/27 may reduce the tax efficiency of pensions. Strategic planning is essential.
Final Thoughts
Inheritance tax is often called a “tax on the unprepared.” However, with some forward thinking and advice, most families can reduce or avoid this liability.
At Ifamax, we provide bespoke inheritance tax planning as part of our holistic financial planning service. We help you make the most of allowances, protect your family’s legacy, and pass on wealth efficiently.
If you’re concerned about inheritance tax or want to understand your position, contact the Ifamax team today. We’ll guide you through your options and help build a strategy that supports your wishes and protects your wealth.
Risk warning
This article is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product. Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.