How to avoid inheritance tax (IHT)

3 min Read Published: 18 Jun 2015

How to avoid inheritance tax (IHT)

how to avoid inheritance tax IHTBenjamin Franklin once penned the phrase 'Nothing is certain but death and taxes' and there is one tax that covers both these terms - that is inheritance tax (IHT). Governments since 1694 have seen death as an opportunity to gather tax in one form or another and in 2013 inheritance tax netted £3.4 billion for the Government. With personal assets on the increase the estates of more and more people are likely to fall under the IHT umbrella.

Yet there are plenty of legal ways to avoid paying inheritance tax (IHT) altogether or least reduce your potential liability to IHT so that you can leave as much of your wealth as possible to your children or anyone else. Below is a list of some of the best ways to avoid paying inheritance tax.

I also suggest that you download this FREE guide to IHT including steps to cut your IHT bill. This is by far the best guide I've seen on the subject and I refer to parts of it later in this article.

Spend it

if you have got assets in excess of the inheritance tax threshold of £325,000 (£625,000 for married couples) then your estate will have to pay 40% IHT on any excess above this amount. So, let's say you are a single person with an estate worth £500,000 then on death your IHT liability will be £70,000 (which is 40% of the difference between £500,000 and £325,000). You could buy a new car and a few holidays with that money. The alternative is that the tax man will keep it when you die.

So the simplest thing to do to reduce your inheritance tax bill is to simply spend the money, assuming you don't need it to live off. This isn't as crazy as it sounds. There is no point hoarding your wealth only to end up handing a lump sum to the taxman when you die. Of course you need to work out how much money you will need in the future to maintain your standard of living. As a guide you would need around a £300,000 pension pot to receive the net equivalent of the average gross UK wage of £26,000.

Give it away

If you intend on passing on your wealth then one way to avoid IHT is to pass it on while you are still alive. That's because you cannot just give all your money away on your deathbed to dodge a potential IHT bill. There are certain gifts you can make during your lifetime that are not liable to IHT:

  • Gifts between a husband & wife or civil partners
  • Gifts to UK charities
  • Gifts to individuals made seven years before their death
  • Gifts made as part of your normal expenditure
  • Gifts to people getting married (within certain limits)
  • Any number of gifts up to £250 per individual
  • Gifts made for maintenance of a former spouse or partner and any children in full-time education and under the age of 18
  • Gifts up to £3,000 in total in any tax tear and you can carry any unused exemption forward one year

If you make a gift to someone and you die within 7 years of the gift being made then there is a potential inheritance tax liability. But the good news is that it is reduced on a sliding scale. So the effective rate of any inheritance tax owed will be less than 40% . This reduction is called taper relief and an explanation of how it works (with examples) can be found here - Inheritance tax (IHT) taper relief on gifts explained.

On page 8 of the FREE guide to IHT mentioned above there is a full list of the exemptions you can possibly claim to reduce your IHT bill. 

Take out life insurance

One of the simplest ways of covering a potential IHT bill is to take out a 'whole of life' insurance policy for the estimated tax due on death. However, unless you are relatively young and healthy this option may prove to be too expensive. If you do take out an insurance policy to cover a future IHT bill make sure you put this policy under trust. Policies under trust do not count towards your estate on death and can also be paid to your beneficiaries prior to probate being granted.

Pass on your pension

From April 2015 new rules apply to how pensions are treated on death.

  • If a pension saver dies before the age of 75 any pension funds could be passed to beneficiaries free of IHT
  • If a pension saver dies beyond the age of 75 then beneficiaries will pay income tax on any money withdrawn at their marginal rate of income tax

This means that an individual, instead of drawing from a pension fund, can shelter the total amount of the fund from IHT. There is also no limit to how many times a pension can be passed on and the same rules apply each time.

A bit of simple planning

As shown above, giving away money or assets is the simplest way to avoid paying inheritance tax and passing more money on to your family. Yet the timing and size of these gifts can influence their effectiveness at reducing any potential IHT bill.

Yet it is possible to put in place other simple measures that will reduce your IHT bill without having to give your money away. Have a look at pages 9 and 10 of the aforementioned FREE guide to reducing your IHT bill to see more details on how gifts and taper relief can help reduce your IHT bill.