1. Give gifts while you're still alive
One way to reduce your inheritance tax bill is to give gifts while you're still alive. However, it’s important that the gift is given outright, otherwise there may still be tax to pay. If, for example, you transfer a property to your children but continue to live there and benefit from it, the gift wouldn’t qualify for exemption. If you’re considering giving any large gifts, it’s important to seek advice from a professional to make sure you’re getting the benefits you expect.
Depending on who you want to leave a gift to, there are a number of allowances you should be aware of:
Annual exemption – Each person can give away £3,000 worth of gifts each tax year without them being added to the value of your estate. And if you didn’t use last year’s exemption, it carries over into this year, making your total annual exemption £6,000.
Wedding or civil ceremony gifts – On top of your annual exemption, you can also leave wedding or civil ceremony gifts up to £1,000 per person. This increases to £2,500 for grandchildren or great-grandchildren and £5,000 if leaving a gift to your own children.
Small gifts exemption – You can also give unlimited gifts up to the value of £250 per person, per tax year, as long as you haven’t used another exemption on the same person.
Remember: the 7 year rule
There is no tax to pay on any gifts you give if you live for 7 years after giving them (unless the gift is part of a trust). If you die within 7 years of giving a gift and there is Inheritance Tax to pay on it, the amount of tax due depends on when you gave it. If you gave the gift:
in the 3 years before your death, it will be taxed at 40%.
3 to 7 years before your death, it will be taxed on a sliding scale known as ‘taper relief’ – this only applies if the total value of gifts made in the 7 years before you die is over the £325,000 tax-free threshold.
It's important to consider this when writing a will. If the value of your estate is worth more than £325,000, it may be more tax efficient for you to give them money while you're still alive. It’s a good idea to seek professional advice if you’re thinking of making gifts to avoid inheritance tax.
2. Leave money to charity in your will
Just like gifts to your husband, wife or civil partner, anything you leave to a UK registered charity is exempt from inheritance tax.
Here's an example:If you leave an estate worth £350,000 and include a charitable gift of £30,000, no inheritance tax would be due. This is because your total taxable estate value would be calculated as £320,000 (£350,000 minus £30,000) and therefore below the £325,000 inheritance tax allowance.
You can also reduce your inheritance tax rate by leaving more than 10% of your net estate to charity. This will reduce your inheritance tax rate from 40% to 36%. Your net estate is the amount left after deducting your inheritance tax allowance.
Here's an example:If your estate is worth £525,000, your net estate will be £200,000 (£525,000 minus your £325,000 allowance). If you then choose to leave £20,000 to charity (10% of your net estate) your inheritance tax rate will be reduced to 36%.
In this scenario, your tax bill would be £64,800, saving you £15,200 in inheritance tax. The charity would receive the full £20,000 and your children would get £440,200 (only £4,800 less than if you didn't leave £20,000 to charity).
By being smart about how you give to charity, you can maximise the efficiency of your estate to benefit a charity close to your heart.
3. Write pensions and life insurance policies in trust
Pensions and life insurance policies can be good ways of minimising your tax bill. With either of these, the policies may need to be written 'in trust'. This usually means that any payouts will not form part of your estate, but will instead go straight to your beneficiaries without being counted towards inheritance tax.
4. Leave everything to your partner
If you're married or in a civil partnership and your partner is domiciled in the UK, you don't have to pay inheritance tax on anything you leave to them regardless of the size of your estate.
Married couples and civil partners are also able to pass on their unused tax allowance to their partner, which can massively increase the surviving partner's tax allowance.
Here's an example:When writing a will, Jane decides to leave her whole £500,000 estate to her husband, John – which means there is no inheritance tax due on her estate.
As Jane didn't use any of her £325,000 inheritance tax allowance, this passes onto John. John's inheritance tax allowance is now £650,000.
When John dies, he shares his £700,000 estate between his nieces and nephews. This is £50,000 over his inheritance tax allowance, so the amount of inheritance tax due is £20,000.
5. Leave the house to your children
In April 2017, the government introduced an additional tax allowance on top of the nil rate band. This gives homeowners an extra £175,000 tax allowance if they leave their home to their children, step-children or grandchildren – or their spouses or civil partners.
Like the nil rate band, it's important to understand this extra tax allowance before writing a will, as it may impact who you decide to leave your estate to.
This allowance is also transferable between married partners and couples in civil partnerships, which can increase the tax allowance for the surviving partner.
Here's an example:In January 2022, Sam leaves his £600,000 estate to his wife, Sarah. No inheritance tax is due on his estate because Sam and Sarah are married.
Sam's £325,000 inheritance tax allowance passes onto Sarah. His £175,000 homeowner allowance will also pass onto Sarah if she decides to leave the house to beneficiaries who qualify for the allowance (such as their children) when writing a will.
When Sarah dies, she leaves her entire £800,000 estate to their children. No inheritance is due on her estate because her combined inheritance tax allowance is £1,000,000 (£325,000 + £325,000 + £175,000 + £175,000).
It’s important to note that if the estate includes a property, and the total value of the estate is more than £2 million, residence nil rate band will reduce by £1 for every £2 that the estate is worth more than the £2 million taper threshold. This applies even when the property is left to direct descendants.
