Magnificent 7… completely legal ways to avoid inheritance tax

Inheritance tax is often known as Britain’s most hated charge, and more and more families are having to pay it.

HMRC raked in a record-breaking £6.1bn in 2021-22, up 14 per cent year-on-year

Rising property prices and a 20-year freeze on the inheritance tax threshold are pulling more families into the net and causing bills to swell in size. The Government’s decision in the Autumn Statement to freeze tax thresholds until 2027-28 is forecast to net an extra £1bn that families would not have had to pay were the bands uprated with inflation

Upon death, the tax is charged at 40 per cent on the value of the estate above the tax-free threshold of £325,000

So with more and more estates in danger of the hated tax, NMTBP shows you how to avoid paying it on your hard-earned assets

Get married

If you want to cut your inheritance tax bill, then it helps to tie the knot. You can pass on assets of unlimited value to a spouse or civil partner without any IHT liability. According to HMRC, such transfers saved spouses a collective £2.6bn in IHT in 2019-20, the most recent year for which data is available

Since the rules changed in 2007, spouses have also been able to inherit their partner’s unused nil-rate band when they die. This means the surviving spouse could see their allowance grow to £650,000

However the unused allowance is not passed on automatically. You must make a formal claim to HMRC within two years of the death of the surviving spouse – otherwise your family could face an unnecessary tax bill

Leave your home to your children

Homeowners get an additional £175,000 allowance – known as the ‘residence nil-rate band’ if they pass their main property on to family members. Married couples/civil partners can enjoy a joint £1 million inheritance tax allowance on their estates, with each spouse qualifying for the full nil-rate band of £325,000 each for a total of £650,000, plus a main residence nil-rate band of £175,000 each for a total of £350,000 (so long as they leave their main property to a recognised descendant)

But beware of some restrictions. The property must be a residence of the deceased and it must be left to children or grandchildren (not nephews, nieces, brothers or sisters)

And for estates worth more than £2m, the residence nil-rate band allowance is reduced at a rate of £1 for every £2 over the threshold. If the residence nil-rate band is not enough to protect your wealth, then you should make the most of gift allowances

Give away money

Perhaps the simplest way to avoid an inheritance tax bill is to give away your assets during your lifetime

An often over-looked but highly tax-efficient method is to give money out of surplus income. This must be money you can give away regularly without significantly changing your lifestyle; it cannot be money that comes from a house sale, for example

The gifts don’t need to be of equal size – they just need to be part of a pattern. You should also keep detailed records of the gifts made, in case HMRC asks for evidence of the gifts after death

On top of gifts out of surplus income, every individual gets a £3,000 annual exemption. Not many realise this can be carried forward for one tax year – so you could give away £6,000 if your allowance was unused in the previous year.

There are additional allowances for weddings or civil partnerships, although how much you can give varies depending on your relationship to the bride or groom:

Relation to bride/groom	Maximum tax-free gift
Parent	£5,000
Grandparent or great-grandparent	£2,500
Soon-to-be spouse	£2,500
Any other relation	£1,000

Another exemption is the small gift allowance, allowing you to give away up to £250 each year per person – though not to anyone who has already benefited from your £3,000 annual exemption

All of these gifts are immediately free from inheritance tax – i.e.they’re excluded from your estate. For gifts outside these categories, a seven-year-rule applies

Make use of the seven-year inheritance tax rule

Large gifts in excess of £3,000 can be made without incurring IHT – but only if you survive the gift by seven years. During this window, the gifts are called ‘potentially exempt transfers’. Gifts made within three years of death are taxed at the full rate of 40 per cent – after that, taper relief will apply at the following rates:

Years between gift and death	Rate of tax on the gift
3 to 4 years	32%
4 to 5 years	24%
5 to 6 years	16%
6 to 7 years	8%
7 or more	0%

Pass on your pension

Regardless of whether you have touched your pension savings, you can pass on the entire pot to your beneficiaries inheritance tax-free

So even if you had used up your nil-rate band and residence nil-rate band, a couple can still give away up to £2,146,200 in pension wealth, thereby saving £858,480 in IHT

Just note that the beneficiary will have to pay income tax as they draw down on the pension, but only if the original pension holder dies after age of 75. Another advantage of incorporating pensions into your estate planning is you can still access these funds if you ever do need to draw on them to pay for care

Take out a life insurance policy

If there is nothing you can do to avoid IHT, you can still insure against the final bill. Taking out a life assurance policy means that when the IHT is due, the charge can be paid out of your policy rather than by your beneficiaries.

However, it’s important the policy is placed inside a trust to shield it from the estate. Otherwise the payout will increase the estate’s value and potentially the amount of IHT due as a result. Also, these plans can be very expensive. The older you are, the higher the premiums will be

Spend it!

There’s little point on scrimping and saving on a tight budget only for your beneficiaries to get hit with the 40% tax! You’ve worked hard to build up your assets, so why not enjoy them? Don’t be emotionally blackmailed by relatives into preserving assets. Spend some of them on ticking things off your bucket list and enjoy your retirement