Inheritance Tax – How To Reduce Your Allowance

At today’s Autumn Budget, the Chancellor chose not to address any changes to the current Inheritance Tax (IHT) allowance, despite a rumoured cut to the tax rate.

The current IHT is a 40% tax on the value of a deceased’s estate, but this only applies if the estate is valued at more than £325,000 and is also not charged on anything left to a husband, wife, civil partner, charity, or some other exempt assets.

If a home is part of the estate and a person’s children and grandchildren stand to inherit it, then the threshold can go up to £500,000 per person and £1m for a couple.

Despite no changes currently, we have outlined below the different ways in which you can reduce your Inheritance Tax (IHT) allowance as it stands.

How can I reduce my inheritance tax bill?

Residential Nil Rate Band (RNRB)

Like the standard nil-rate band, unused elements of the allowance are transferable to a surviving spouse or registered civil partner. The RNRB for the current 2023/24 tax year, and up until 2025/26, is £175,000 per person.

This means that a married couple with children, or grandchildren can potentially pass on up to £1 million without having to pay IHT if the second death occurred this tax year.

Gifting

Each year you can give away £3,000 as a gift, and this will not be subject to IHT. You can also gift £250 to any number of people each year. Parents can gift £5,000 to each of their children as a wedding gift, while grandparents can give £2,500, and anyone else £1,000 for wedding gifts.

Gifts of any size to charities or political parties are also IHT-free. If a gift is regular, comes out of your income, and does not affect your standard of living, any amount of money can be given away and ignored for IHT.

It is possible to make further tax-free gifts of any size – potentially exempt transfers – but you have to survive for seven years after making the gift to get the full benefit of it being outside of your estate for IHT purposes.

Trusts

Another way you can move capital/assets out of your estate is to gift them into Trusts. This can reduce an IHT bill and give you control over how your assets are used by future generations. Gifting into a Trust is a complex matter, and it will take up to seven years to fully remove the capital from your estate, however in most circumstances, any growth or interest on the money gifted into Trust is outside of your estate straight away.

Pensions

Alongside their benefits for retirement planning, pensions are one of the most tax-efficient ways to pass on your wealth, as capital within pensions will fall outside of your estate straight away. If you pass away before the age of 75, benefits left in a money purchase pension can be paid as a lump sum or drawdown income to any nominated beneficiary, with absolutely no tax to pay.

If death occurs after the age of 75, any future withdrawals will be taxed at the beneficiaries’ marginal income tax rate. However, if the beneficiary does not require any withdrawals, the money can remain in the pension sheltered from IHT on their own estate. It therefore might make sense to use other investments, such as Individual Savings Accounts (ISAs), to provide a retirement income and retain funds in your pension for as long as possible.

It is important to seek advice to ensure your pension facilitates this option and does not automatically pay out a lump sum death payment, removing the money from the pension ‘wrapper’.

Special investment and life assurances are also ways to reduce your prospective IHT bill, and while all of these options can result in a beneficial outcome, IHT planning can be complicated. It is best to speak advice from a professional and forward plan as early as possible.

What might we see in the Spring budget?

Originally, rumours suggested that the Government would look to reduce Inheritance Tax either directly through the rate of tax or by increasing people’s allowances. Although there was nothing in the Autumn Statement this time, these changes may have just been deferred until May as the Conservatives look towards a difficult election.

Whether it is pre-election changes or alterations from the new Government after the election we would expect changes at some point, so it is important to keep plans flexible and review them on a regular basis.