Protect your estate: strategies to reduce inheritance tax

Talking about death is never easy but conversations about inheritance tax (IHT) have become increasingly common in recent times - and for good reason.

More than half of us (60%) want to leave a legacy to our loved ones, according to our Real Life Advice Report.¹  However, the goalposts for passing money on have moved considerably. In last year’s Autumn Budget, the chancellor announced that, from 2027, unspent pension pots would be counted as part of an estate and therefore could be liable for up to 40% IHT. Not only that, but with the nil rate band and residence nil rate bands remaining frozen until 2030, thousands more people could be caught in the IHT net.

This comes at a moment when inherited wealth is at an all-time high. In the next 30 years so-called baby boomers (those born between 1946 - 1964) are expected to pass on an unprecedented £7 trillion² to Gen Z and Millennials It’s being called the greatest wealth transfer in history – but for many, it may come with an unwelcome IHT bill. However, practical and timely estate planning can help you pass on more to those you love. 

I think there will be an IHT bill on my estate – what can I do?  

• Start regular gifting, using your gifting allowance
• Consider a larger gift 
• Make a gift to charity or leave a legacy
• Ringfence larger assets in a discretionary trust
• Set up a whole of life insurance policy written in trust
• Review your Wills to ensure that they are as tax-efficient as possible

Give more money away

Lifetime gifting is a straightforward way to begin reducing your IHT bill. By gifting money during lifetime, that would have been part of an inheritance anyway, you reduce the size of your estate so that there is smaller amount subject to IHT on your death. You also have the opportunity of seeing other people realise their own goals and ambitions too.

Each tax year, you can give away £3,000 without any IHT consequences – this is your ‘annual exemption’. If you and your partner both make use of the exemption, that’s £6,000. As a bonus you can carry the annual exemption forward one year, if you don’t use it. So, a couple could potentially gift up to £12,000 and this would reduce their estate by that amount with immediate effect.

Can I gift more than £3,000 a year?

You can gift any sum of money you want – with one important ‘health warning’. Your gift could fall back into your estate if you die within seven years of making the gift, and may be liable for IHT as a result. This is known as the seven year rule.

The good news is that if you do die within 7 years - and the gift itself gives rise to an IHT liability on death (which could happen if the amount of your gift is greater than the nil rate band) - the IHT liability tapers off the longer you live. Furthermore, if you want to protect your gift, you can insure it with what’s called an inter vivos life insurance policy. But before your generosity gets the better of you, talk your plans through with a financial adviser, just to make sure you don’t gift but live to regret it.

Gifting out of disposable income

Gifting out of regular income is another potential option for reducing your IHT liability in your lifetime. If you gift surplus income on a regular basis as part of your ‘normal expenditure’, it’s immediately removed from your estate. So, you could decide to use surplus income to help cover a grandchild’s first mortgage or contribute towards school fees.

The golden rule is that the gift is from surplus income, in other words money you don’t need to live on. It can’t come from savings, and it must not reduce your standard of living to the extent that you need to then resort to your capital in order to maintain yourself. This form of gifting has another benefit that protects you too. Since it’s discretionary, you can stop it, increase or decrease it, if your own situation changes. If you plan to make gifts out of surplus income, it’s important that you keep records of income, expenditure and the amount of surplus income gifted to make it easier for your personal representatives to claim the exemption following your death.

Gifting for the greater good

Legacy gifts or bequests are a lifeline for charities, as well as being a useful estate protection tool. Not only are gifts made to charities exempt from IHT (whether made on death or during lifetime), if you’re planning to leave more than 10% of your estate to charity on your death, the IHT rate payable on the rest of your estate could fall from 40% to 36%. You can either leave a lump sum legacy, or a percentage of your estate but it is important that you take advice from a solicitor to ensure that the amount gifted meets the 10% rule.

Using a trust to protect your estate

.Discretionary trusts are often used to help people pass on assets such as money or property in a controlled and flexible way which also ring-fences the gifted assets from third party claims. Once an asset is inside a trust, it usually sits outside your estate after 7 years, and therefore isn’t liable for IHT. However, if the amount gifted to a discretionary trust is more than your available nil rate band then IHT at the rate of 20% will be due at the time the gift is made. Discretionary trusts do what it says on the tin. The trust money will be paid out at the discretion of the trustees, who decide how much the beneficiaries get and when. You should leave a letter of wishes with your trustees, making it clear who you want the money to go to and what it can be used for.

Trusts can be both versatile, and tax-efficient, but they’re often seen as complicated or only for the very wealthy. Neither is strictly true, but it always pays to talk to a financial adviser to help you pick the right trust for you. Advisers can also help make sure the right trustees are in place, register the trust and keep the details up to date. 

Taking a whole of life insurance policy to cover your IHT bill

Many people who know they are going to have an IHT bill are exploring whole of life insurance policies written in trust to either pay or compensate their intended beneficiaries for the IHT that will be payable on their estate. In 2022, the most recent year for which figures are available, an estimated 2.5 million such policies were sold.

Life insurance policies are a way to ensure you leave a lump sum behind you when you die. Families can use the money to settle the IHT bill or pay off other debts or bills, and importantly, your personal representatives don’t need to wait for probate for the money to come through.

Any whole of life policy must be written in trust (which is simple to do) otherwise the payout will fall back into the estate again and potentially be liable for IHT itself.

With whole of life policies, the key word is sustainability. Once you start paying, you can’t stop without potentially forfeiting what you’ve paid in. Premiums can escalate and may be high to start with, so it’s crucial to take financial advice to make sure you’ll be able to afford them for as long as you expect to live...

Almost one in five adults said financial advice had helped them to leave a better inheritance for their children, according to our recent consumer survey, The Real Life Advice Report. ³ The more we talk to each other about money, not just inheritances, the more we discover about each other’s hopes, ambitions and dreams.

The importance of financial advice

Financial advice will help you create a fair, sustainable legacy plan to help keep your money where it belongs. In the family.

You can also use our IHT calculator to give you an estimate of what how much your estate is likely to pay on current values.

Ready to explore your estate planning options?

Get in touch with us today.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place and along with Trusts are not regulated by the Financial Conduct Authority.

Sources:

¹The Real Life Advice Report was commissioned by St. James’s Place. Opinium surveyed just under 12,000 UK adults nationwide in two polls between May and August 2024. Quotas and post-weighting were applied to the sample to make the dataset representative of the UK adult population. Quantitative data referenced is sourced from the first poll which had a total sample of 7,995 respondents. Survey included those aged 18-34 (1,940), aged 35-54 (2,654) & aged 55 and over (3,401).
²Unbiased: the Great Wealth Transfer3Financial Conduct Authority
³What's the real-life value of financial advice? - St. James’s Place Opinium surveyed just under 12,000 UK adults between May and August 2024. Quotas and post-weighting were applied to the sample to make the dataset representative of the UK adult population. Quantitive data referenced is sourced from the first poll which had a total sample of 7,995 respondents.