5 things you need to know about Inheritance Tax

4th February 2022

Inheritance Tax is complex. Here, we highlight its key exemptions and allowances – but to ensure you minimise your bill, seeking expert financial advice is a must.

The quick read:

  • Much of the tax paid on estates after death can be avoided with meticulous planning.
  • It’s important to take maximum advantage of the exemptions, allowances, gifting and other investments summarised here.
  • Taking advice from a St. James’s Place Partner will help you navigate the complexity of Inheritance Tax.

Inheritance Tax (IHT) is one of the government’s most reliable forms of income. IHT receipts received by HMRC during the tax year 2020-2021 came to £5.4 billion and have remained around that level for the past four years, according to official statistics1.

Yet so much of the tax paid on the value of your estate after you die is avoidable. With careful planning to ensure full use of exemptions, gifting and other tax-efficient investments, it is possible to mitigate and minimise much of the IHT you would otherwise pay.

Failure to put those plans in place can significantly reduce what you are able to pass on to loved ones. Assets such as your family home, bank accounts, ISAs, jewellery, art and antiques are subject to IHT at the standard rate of 40% after the first £325,000.

Here are the five most important things you need to know about IHT – but were too afraid to ask.

1. Taking advice can change your future

IHT is a highly complex area. You will not know every rule, exemption and allowance and how to use them – and you’re not expected to.

Taking advice can help mitigate your IHT as part of broader planning for later life that also includes retirement income, planning for social care, giving money away when you’re alive and passing it on when you’re dead.

There is no set age for when you should start planning – and it differs for each person – but it will often begin at a point when your savings and assets begin to accumulate. This might coincide with children becoming less financially dependent and mortgage payments reducing or disappearing.

Formulating a plan prevents you from making reactionary decisions and reduces the chances of a nasty tax surprise.

2. IHT thresholds and rates can vary

Understanding how thresholds work can instantly minimise a big chunk of what your IHT bill is likely to be.

  • There is no IHT to be paid, even above £325,000, if you leave everything above that threshold to your spouse, civil partner, a charity or a community amateur sports club.
  • Your tax-free threshold increases to £500,000 if you give away your home to your children, step-children or grandchildren, subject to your estate being less than £2m.
  • A reduced IHT rate of 36% is payable on certain assets if you give away 10% or more of the net value of your estate to charity.

3. Gifting is a straightforward way to mitigate your IHT

Gifting helps you support your family at the same time as reducing your IHT liability. You can give away up to £3,000 each tax year (your ‘annual exemption’), as well as make any number of small gifts up to £250 per person, and not incur IHT.

Almost all gifts become IHT exempt if you survive for seven years. These are the main factors to consider:

  • Gifts to your spouse or civil partner are exempt from tax during your lifetime, or upon death.
  • A tax-free allowance of up to £3,000 applies to gifts made to other beneficiaries. You can carry the allowance over for one tax year, meaning you could give away up to £6,000 in a tax year.
  • Gifts to children or grandchildren to pay for a wedding or civil partnership are exempt from IHT and are considered separate to the £3,000 annual exemption. You can give up to £5,000 to a child or £2,500 to a grandchild. This is a good way to pass on some of the value of your estate in the form of a gift you would probably have made anyway.
  • Gifts made from your regular income are tax free, as long as you can prove they do not diminish your own standard of living.
  • Gifts above the allowance are exempt from IHT if you survive for seven years after making the gift. Gifts above the nil rate band, made between three and seven years before your death are taxed on a sliding scale – known as ‘taper relief’. The longer the time, the less you pay.

4. Pensions should be considered in IHT planning

Most Defined Contribution schemes will fall outside of your estate, so if you’re looking for a tax-efficient way to pass on wealth, pensions could form part of the solution.

You might have different pension pots and choose to pass one or more to your children or grandchildren.

If you die before you are 75, your pension pot can be paid as a lump sum or income to any beneficiary, free from tax. After 75, beneficiaries will need to pay tax at their marginal rate on withdrawals.

5. Trusts help you stay in control of your money and mitigate IHT

Trusts are a traditional part of IHT planning and remain an effective way to ensure the right people get the right money at the right time.

There are several different types of trust and ways of setting them up. In some cases you can access the funds; in some you can’t.

Trusts can be complex, so you should always speak to a St. James’s Place Partner before you begin the process of setting one up.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

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

Trusts are not regulated by the Financial Conduct Authority or the Prudential Regulation Authority.

1 Inheritance Tax statistics: commentary, HMRC National Statistics, updated 29 July 2021