8 Tips to Legally Avoid Inheritance Tax

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By Crispin Bateman
Updated on Tuesday 23 November 2021

Maze representing the avoidance of inheritance tax

If you are looking at passing on your estate (including your home, savings and possessions) to your loved ones when you pass away, you will probably have worried at least a little about inheritance tax (IHT). There’s plenty of scaremongering about the system and it’s easy to believe that your assets will be stripped of 40% by the tax office, or that you’ll do something wrong which affects your beneficiaries.

Don’t worry! Here at Compare UK Quotes, we have plenty of advice to help you understand inheritance tax and how to avoid it using completely legal methods. If you’ve already read our guide on inheritance tax, read on for eight handy ways you can avoid or reduce your inheritance tax bill legally!

Tips to avoid inheritance tax in the UK Infographic

#1 - Know your nil rate bands and the IHT threshold 

The Nil Rate Band (NRB) is the threshold under which you don’t have to pay inheritance tax – and it’s a sizeable amount. Currently, it’s set to £325,000 which means, quite simply, that if you are passing on assets worth £325,000 or less then there’s no inheritance tax to pay.

Note that the inheritance tax threshold will be reviewed in 2021 and could change in line with the Consumer Price Index (CPI).

RNRB explained: Avoiding inheritance tax on property

Of course, property is the big thing that can easily push on the edges of the NRB, but there’s a little extra to help there too. Avoiding inheritance tax on property is made easier thanks to the RNRB – or the Residence Nil Rate Band.

This is an extra amount which is additional to the overall NRB which counts for property left to children or grandchildren. In this tax year, 2020/21, the RNRB is set at £175,000, but remember that it will increase in line with inflation every year from now on, based on the Consumer Price Index UK.

The RNRB only applies to children (including step-children and adopted children) and grandchildren, but it adds that extra boost to allow them to keep the home without worrying about IHT.

#2- The seven year rule: Inheritance tax on gifts

People you give gifts to will be charged the standard 40% inheritance tax rate if you give away more than £325,000 in the seven years before your passing, according to the government.  

Unfortunately, you can’t just give your money and house away in the months before you die and hope that it doesn’t become subject to IHT. Neither can you sell your house for £1 to your grandson and get away with not paying the right amount of tax.To prevent this type of simple avoidance scam, the tax office instigates a seven-year rule on gifts with regard to inheritance tax. Almost anything you gave away in the seven years before your passing is 100% liable to inheritance tax.

What counts as a gift for inheritance tax purposes? Anything that has a value – including money, properties, and almost any other possessions. It can also be anything that could be considered a loss in value when it’s transferred - for example, a property that is sold for less than its worth. In those cases, the difference in value is considered a gift.

Of course, with every rule, there are exceptions and with gifts you are entitled to pass on:

  • £3,000 worth of gifts each year. This can also roll-over to £6,000 in a second year if not used.
  • £5,000 for the occasion of a child’s wedding or £2,500 for a grandchild’s wedding day.
  • Money to help the living costs of a child (under 18), elderly dependant or ex-spouse.
  • Money from your surplus income (additional money once all your living costs are paid for). A good example of this is regularly putting money in a grandchild’s savings account.

It’s important that you keep records of any gifts you give in this way to have the best chance of avoiding inheritance tax.

One important area which cannot be worked around is that of housing – you cannot simply give away your house for it to be lived in, nor sell it for less than its market value to a relative. This is especially true if you plan to remain living there.

If you do pass your house on to a relative and remain in situ, you must:

  1. Sell it for market value, or a reasonable near amount.
  2. Pay rent to the new owner of the house, again at market value.
  3. Properly document and legalise all transactions.

The difficulties in transferring hands of a home in this way, plus the level of trust required, are such that it usually isn’t worth doing.

Giving away a home to avoid inheritance tax on property has issues beyond the usual seven-year period. If you give away your house (for substantially less than the market value) and continue to live in it (for less rent than the market value) then it will count for inheritance tax no matter how many years have passed.

If you wish to pass your house on to another before your death, then it is worth seeking specialist advice.

#3 - Be married (or in a civil partnership): Inheritance tax marriage allowance

Your spouse or civil partner can inherit your estate in full without being subject to IHT, thanks to the tax-free allowances for married couples and civil partners. Additionally, if this is done then they hold your nil rate band value when they then pass on the possessions to your loved ones.

What this means is that if you have an estate valued at £650,000 between you, and you die first and pass it all on to your spouse, when they then die and pass on the estate, none of it is liable for inheritance.

Again, documentation is important and good records can help stop a lot of headaches.

For more information and advice, take a look at our related articles below:

#4 - Give to charity: The inheritance tax charity exemption

If you decide to leave part of your estate to a charity when you pass away, then it will not count towards the taxable value of your estate and the entire amount will be exempt from inheritance tax.

This is called leaving a charitable legacy, and there is no limit to the amount that can be passed to a not-for-profit organisation.

It’s also worth noting that you are able to reduce the inheritance tax bill on the rest of your estate by four percent – from 40% to 36% – if you pass at least 10% of your ‘net estate’ to a charity.

#5 - Use life insurance to pay the inheritance tax

While it doesn’t necessarily help you avoid inheritance tax, having someone else pay for it is pretty close! A properly set up life insurance policy which pays into trust will enable you to cover the inheritance tax for your heirs and rid them of any of the responsibility, thus benefiting them financially and emotionally following your death.

In order to do this, you would take out a life insurance policy (either level-term or whole of life) which has a sum assured equal to (or greater than) the expected total inheritance tax amount. Upon your death, this policy would pay out to a trust, insuring that it is not part of your estate, and provide an influx of cash set aside to cover the IHT.

#6 - Put some assets in trust

Similar to life insurance, other assets in trust do not form part of your estate and are therefore exempt from inheritance tax. An example could be to leave money or shares to be used for a young relative when they become 18.

Trusts are also useful ways of ensuring that the assets you leave behind to your relatives are used in line with your wishes. Legally, the assets must be distributed and used for the particular purpose that you specified when setting up the trust, which provides you with an invaluable peace of mind.

#7 - Write a will

It is important that your wishes for your estate are known, especially if that estate is complex or to be split in a specific way (if you have step-children, for example). If you have life insurance, stocks or any other additional assets then make sure they and their intended use are detailed.

Without a will, your estate could be distributed according to intestacy rules and not in a way that was intended by you or in favour for your heirs.

Read more:

#8 - Spend it!

The one person who can use your funds without worrying about any inheritance tax is you, so why not spend it while you can?

Spending your money before you die is a perfectly acceptable way of avoiding inheritance tax, especially if you do not have any dependants – whether it’s a glorious cruise holiday or a string of impressive parties.

It’s your money so have fun with it; you can always bring your relatives along for the ride!

You might like:

A Complete Guide to Inheritance Tax

Types of Life Insurance Policies

Putting Life Insurance in Trust

Wills and Probate Resources 

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