Inheritance tax: how to cut your bill

Years of frozen allowances, paired with house price growth and soaring inflation, is dragging more people into inheritance tax, but there are ways to reduce the tax liability

In line with previous months, the latest figures on tax receipts for January show that inheritance tax (IHT) continued to rise with total receipts of £5.9bn so far this year, up £600m in December and on track to exceed the 2021-22 tax year by £900m. The failure to change thresholds for years is drawing more and more estates into the death taxes.

While the average bill was £216,000 in 2019/20, research conducted by Wealth Club suggests the average inheritance tax bill could reach £270,831 by 2025-26 and £288,611 by 2027-28 if current inflation expectations are met.

Alex Davies, CEO and founder of Wealth Club said: ‘The revenue generated from inheritance tax plays an important part in the government’s spending programme. But this is no longer something just the very wealthy need to worry about.

‘Families up and down the UK, most of which would not consider themselves to be especially affluent, are increasingly being affected. 

‘No one likes to pay more tax than they need to, but the good news is that with a little bit of planning, there are a number of perfectly legitimate ways to reduce your liability.

‘One of the great IHT threats arguably comes from where you least expect it: your ISA. Whilst tax efficient in so many other ways, ISAs form part of a person’s taxable estate along with other savings, investments and possessions, so up to 40% of could be eaten up by inheritance tax rather than passed to your loved ones.

‘An alternative option is to invest in certain AIM shares within your ISA. Many AIM shares qualify for  business property relief. Providing you hold them on death and have been invested for at least two years they should be free of inheritance tax. You can choose the investments yourself or opt for the hassle free approach of a professionally managed portfolio.’

Ways to cut your inheritance tax bill

Make a will

Making a will is the first step you should take. Without it, your estate will be shared according to a set of pre-determined rules. That means the taxman might end up with more than its fair share.

Use your pension allowance

Pensions are not usually subject to IHT for those under 75 years old – they can be passed on tax efficiently and, in some cases, even tax free. If you have any pension allowance left, make use of it.

Set up a trust

Trusts have traditionally been a staple of IHT planning. They can mean money falls outside an estate if you live for at least seven years after establishing the trust. The related taxes and laws are complicated – you should seek specialist advice if you’re considering this.

Invest in companies qualifying for business property relief (BPR)

If you own or invest in a business that qualifies for business property relief – the majority of private companies and some AIM-quoted companies do – you can benefit from full IHT relief. You must be a shareholder for at least two years and still be so on death.

Invest in an AIM IHT ISA

ISAs are tax free during your lifetime but when you die, or when your spouse dies if later, they could be subject to 40% IHT. An increasingly popular way of mitigating IHT on an ISA is to invest in certain AIM quoted companies which qualify for BPR. When you die as long as you still own the shares and have done so for at least two years you should be able to pass them on without a penny due in inheritance tax.

Back smaller British businesses

The enterprise investment scheme (EIS) and the seed enterprise investment scheme (SEIS) offer a generous set of tax reliefs. For instance, SEIS offers up to 50% income tax and capital gains tax reliefs, plus loss relief if the investment does not work out. But EIS and SEIS investments also qualify for BPR, so could be passed on free of IHT after two years.

Invest in commercial forestry

This is an underused option for experienced investors. Pension funds and institutions have long ploughed money into forestry. The Church Commissioners has a forestry portfolio worth £400m.

Commercial forest investments should be free of IHT if held for at least two years and on death. You should also benefit from capital appreciation in the value of the trees (and the land they are on) and from any income produced by harvesting the trees and selling the timber (this income may also be tax free). 

Use your gift allowances

Every year you can give up to £3,000 away tax free. This is known as the annual exemption. If you did not use it last year, you can combine it and pass on £6,000.

You can also give up to £250 each year to however many people you wish (but only one gift per recipient per year) or make a wedding gift of up to £5,000 to your child; up to £2,500 to your grandchild; up to £2,500 to your spouse or civil partner to be and £1,000 to anyone else.

Beyond these allowances, you can pass on as much as you like IHT free. So long as you live for at least seven years after giving money away, there will be no IHT to pay. 

Make regular gifts

You can make regular gifts from your income. These gifts are immediately IHT free (no need to wait for seven years) and there is no cap on how much you can give away, provided you can demonstrate your standard of living is not affected.

Leave a legacy – give to charity

If you leave at least 10% of your net estate to a charity or a few other organisations, you may be able to get a discount on the IHT rate – 36% instead of 40% ¬ on the rest of your estate.