This article explores all you need to know about UK inheritance tax (IHT). We explain who pays inheritance tax, how much inheritance tax might be due, and all the issues you need to know if you want to avoid paying inheritance tax legally.

1. Inheritance tax overview

Inheritance tax is payable in the UK on death, and sometimes when you give away certain assets during your lifetime. If you are UK resident, inheritance tax is paid on your worldwide assets (subject to certain taxation treaties); if you are resident outside of the UK inheritance tax is usually paid only on UK assets (as the country you live in will have its own rules).

After you die, your representatives will need to count up the value of all of your assets and take away any liabilities (debts). The remainder is called your “estate”, and this value is what may be liable to inheritance tax (IHT).

How do you calculate your estate for inheritance tax?
What is the UK inheritance tax rate?
The inheritance tax nil rate band
The inheritance tax residential nil rate band

Key points:

  • How inheritance tax works in the UK
  • Inheritance tax examples
  • 7 strategies to avoid inheritance tax

How inheritance tax works in the UK

Inheritance tax (IHT) is usually levied on death, although it is sometimes paid on certain gifts.

When you die, your estate is calculated. All your assets are added together and a total is produced. Certain assets may be excluded, such as the value of a joint tenancy if you own a property, since this passes to the survivor(s) on your death. If you are domiciled in the UK all your worldwide assets are subject to inheritance tax.

Everyone has a tax-free band, which can be used to avoid inheritance tax. This is called the nil rate band. Currently, this is £325,000. Assets over this figure are taxed at 40%.

A simple inheritance tax example

John has a number of assets worth £1,000,000. When he dies he leaves a will giving all these assets to his daughter Jane. Jane calculates that the assets above John’s nil rate band are £675,000. Since tax on this amount is at 40%, Jane must pay £270,000 in inheritance tax before she can take possession of John’s remaining assets. Jane will receive the remainder – £730,000. 27% of John’s estate goes to the tax authorities, which means that Jane wishes that John had done more to avoid inheritance tax in his lifetime!

Inheritance tax for married couples

If you are married or in a civil partnership you are allowed to double up on your inheritance tax threshold, or nil rate band. Transfers between spouses are tax-free for inheritance tax purposes, so you can freely give all your assets to your spouse on your death. In this scenario, no inheritance tax is payable. What happens is that the assets of the first spouse to die pass to the survivor. On the death of the second spouse, the combined estate will be taxed. There is one benefit of being married and that is that you can combine the inheritance tax threshold of both spouses on second death.

An example of inheritance tax for married couples

Bill has  assets worth £500,000, and so does his wife Mary. When Bill he dies he leaves a will giving all these assets to his wife Mary. Mary receives Bill’s assets tax free, and now has a combined estate of £1,000,000. When Mary dies, she leaves all her money to her son David. David gets to use both Bill and Mary’s nil rate bands, so the first £650,000 of Mary’s estate is tax free. David must pay tax at 40% on the £350,000 excess over the inheritance tax threshold, which is £140,000. David wishes that his parents had done more to avoid inheritance tax during their lifetimes!

7 strategies to avoid inheritance tax

Here are some good ways to consider if you want to avoid inheritance tax. These are not the only ways that you can avoid inheritance tax, but are certainly tried and tested, and are the most common.

  1. Make a will
    One of the best ways for you to avoid inheritance tax is to make a will. This allows you to choose how your assets will be treated on death, so you can do some careful planning and therefore avoid inheritance tax. If you do not make a will, the state will decide how your assets are distributed. This will not be the most efficient way for you to avoid inheritance tax!
  2. Give assets away during your lifetime
    You can make as many gifts as you like during your lifetime. This can be the best way to reduce the value of your estate and therefore is a good way to avoid inheritance tax. Of course, you may feel nervous about giving away your assets while you are still alive since you may feel you could need the money in the future. With careful financial planning you can work out how much you can afford to give away to avoid inheritance tax and still have enough left over to fund your future lifestyle.Most lifetime gifts are known as potentially exempt transfers (PETs). Any such gifts will only be effective to avoid inheritance tax if you survive for 7 years from the date of making the gift. If you die within 7 years the gift will drop back into your estate for tax purposes. Gifts above the nil rate band attract taper relief, and will reduce the value attributed to your estate on a sliding scale if you survive between 3 and 7 years. This can be a complex area.Certain gifts are Lifetime Chargeable Transfers (LCTs). These include gifts to trusts, and are taxed at 20% at the date of the gift, with 20% tax paid on death.
  3. Use inheritance tax exemptions
    Certain gifts are exempt from inheritance tax. These include the following:


    1. Gifts to spouses
      As previously mentioned, anything you give to your spouse during your lifetime or on death is free of inheritance tax. Of course, when your spouse dies inheritance tax could still be payable. However this can be useful to avoid inheritance tax especially when one spouse is younger than another.
    2. Annual exemption
      You are permitted to give away up to £3,000 in any one tax year without attracting inheritance tax. If you have not used this allowance in the previous tax year you can bring this forward for 1 year only. Thus, you could double this up to £6,000. If you are part of a married couple you could give away £12,000 in one tax year.
    3. Small gifts
      You can give away up to £250 as many times as you like to as many people as you want.
    4. Wedding gifts
      There are rules around gifts to children or grandchildren on consideration of marriage. Certain amounts can be given away without attracting inheritance tax.
    5. Gifts to charities or political parties
      You may give as much money as you want to charities or political parties and effectively avoid inheritance tax.
  4. Gifts out of income
    Since you have already paid tax on your income you can give away any excess without paying inheritance tax. This must be done carefully to avoid inheritance tax effectively. You should document your gifts carefully, and it should be clear that your lifestyle is being funded from the retained income. If you give away amounts from your income you cannot rely on capital to fund your expenses.
  5. Use trusts
    Trusts are an effective legal mechanism to help you to avoid inheritance tax. You can make gifts to trusts, which may allow you to exercise some control over the assets. There can be tax advantages to gifts to trusts, but there is added complexity and cost involved. Trusts are taxed heavily, so you should only make gifts to trusts after taking advice. Otherwise you may find yourself avoiding inheritance tax only to end up paying an alternative tax.You may be able to place existing assets into trust to avoid inheritance tax. You can do this easily with pensions and life assurance. For example, most pension plans can be written into trust so that on your death the assets pass outside your estate and go straight to your relatives without paying inheritance tax. If you have set up life assurance you should put this policy into trust. This helps you to avoid inheritance tax as it excludes the value of the policy from your estate, and you therefore ignore the value for tax purposes.
  6. Do some inheritance tax planning
    With some careful planning you can effectively avoid inheritance tax. You can take out certain investment products,which have particular inheritance tax treatments.  this can enable you to gain an income from the product, while still removing money from your estate and thus avoiding inheritance tax.  These schemes tend to be more complex, but can be extremely effective.
  7. Buy inheritance tax insurance
    This is not really a way to avoid inheritance tax – it is more a way to ensure that the liability is funded when you die.  you can set up a whole of life insurance plan which will pay out a lump sum on your death. this will then ;pay the tax due at that point. If done correctly, the net result is that your relatives will receive the amount they expect, but the policy will pay the tax due. Of course, you should write this policy in trust to ensure that the tax situation is not made worse.the downside of this approach is that there is a cost to the cover, which can be significant as you get older.  However, the main advantage is that it is a simple solution which leaves you in full control of your assets while you are alive.n

There are many other ways to avoid inheritance tax. These are only the most straightforward and popular methods. If you would like to examine ways to avoid inheritance tax, please contact us.

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Dan Woodruff

Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.

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