Inheritance Tax (IHT) is often a source of anxiety for families, especially as property values rise and more estates are caught by the tax. At 40% on anything above the threshold, the impact can be significant. However, with careful planning and a clear understanding of the rules, you can take practical steps to reduce the tax burden and ensure more of your wealth passes to your loved ones.

Understanding the Nil Rate Band and Residence Nil Rate Band

The standard Nil Rate Band (NRB) is £325,000 per person, and it’s set to remain at this level until at least 2028. Anything above this is potentially taxed at 40%. However, if you leave your main home to direct descendants—children, stepchildren, or grandchildren—you may also benefit from the Residence Nil Rate Band (RNRB), which is currently an extra £175,000. This means a married couple or civil partners could potentially pass on up to £1 million tax-free, provided both bands are fully available and transferred.

It’s important to note that the RNRB tapers away for estates worth more than £2 million, so larger estates may not benefit fully. Many people mistakenly believe the RNRB applies to all property or to all beneficiaries, but it is strictly limited to direct descendants and only applies to a single ‘main residence’.

Combining Allowances: How It Works in Practice

When the first spouse or civil partner dies, any unused NRB and RNRB can be transferred to the survivor. This is not automatic—you must claim the transfer when the second person dies, and you’ll need to provide evidence of the first death and the unused allowance. Failing to do this is a common pitfall and can result in unnecessary tax.

Gifting: Exemptions, the Seven-Year Rule, and Common Misunderstandings

Gifting is a popular way to reduce the value of your estate, but the rules are often misunderstood. You can give away up to £3,000 each tax year without it counting towards IHT, and this can be carried forward one year if unused. Small gifts of up to £250 per person per year are also exempt, but you can’t combine this with the £3,000 exemption for the same person.

Regular gifts from surplus income are immediately exempt, but you must be able to show that these gifts did not affect your standard of living. This is often scrutinised by HMRC, so keeping clear records is essential.

Larger gifts are known as Potentially Exempt Transfers (PETs). If you survive for seven years after making the gift, it falls outside your estate. If you die within seven years, the gift may be taxed, with the rate tapering after three years. Many people forget that if you continue to benefit from the asset (for example, by living in a house you’ve ‘gifted’), the gift may be treated as a ‘gift with reservation of benefit’ and still count towards your estate.

Trusts: Flexibility and Traps to Avoid

Trusts can be a powerful tool for IHT planning, but they are not a magic bullet. Discretionary trusts, bare trusts, and interest in possession trusts each have different tax implications and administrative requirements. For example, assets placed in a discretionary trust may be subject to an immediate 20% IHT charge if they exceed the NRB, and there are ongoing charges every ten years. Bare trusts, on the other hand, are treated as outright gifts for IHT purposes.

A common pitfall is failing to keep up with trust administration or misunderstanding the tax treatment of different types of trusts. Always ensure you understand the ongoing obligations and reporting requirements.

Business and Agricultural Relief: Not Just for Farmers

If you own a business or agricultural property, you may qualify for Business Property Relief (BPR) or Agricultural Property Relief (APR), which can reduce the value of these assets for IHT by up to 100%. However, not all business assets qualify—investments, for example, are usually excluded. The rules are strict, and HMRC will look closely at the nature of the business and your involvement. If you’re considering passing on a business, it’s wise to review the structure and ensure it meets the criteria for relief.

Life Insurance: Covering the Bill

A whole of life insurance policy, written in trust, can provide funds to pay any IHT due. This means the payout does not form part of your estate and can be accessed quickly by your beneficiaries. However, premiums can be expensive, especially as you get older, and it’s important to review the policy regularly to ensure it still meets your needs.

Practical Steps and Common Pitfalls

Start by calculating your potential IHT liability, taking into account all assets, including property, savings, investments, and life insurance. Review your will and ensure it reflects your wishes and makes the best use of available allowances. Consider gifting strategies, but keep clear records and be mindful of the seven-year rule. If you use trusts, make sure you understand the tax implications and administrative requirements.

Regularly review your estate plan, especially if your circumstances change or if there are changes in the law. Many people are caught out by failing to update their plans after a significant life event, such as marriage, divorce, or the birth of a child.

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Disclaimer: This blog post provides general information for educational purposes only. It is not legal advice. Outcomes can vary based on your personal circumstances.