When the 2022/23 tax year starts, freezes on certain allowances that were introduced by the chancellor in 2021 come into effect. One such freeze is the nil-rate band (NRB), which is the amount you can have in your estate on death before Inheritance Tax (IHT) is due.

When the freeze was announced in March 2021, pension provider Canada Life suggested it could generate an additional £985 million for the Treasury. When you consider a recent article by FTAdviser, it could be significantly more.

According to the article, the Treasury took £600 million more in IHT receipts between April and December 2021 alone when compared to the same period in 2020. As you can see, taking action to reduce or negate any IHT liability is probably more important than ever.

Read on to discover how IHT works and how to reduce, or even negate, an IHT liability.

Inheritance Tax is typically charged on your worldly belongings

Each individual has an IHT NRB, meaning that the tax is only due on the value of your estate above this band. Your estate includes the value of assets you hold, such as investments, property, shares, ISAs, bonds, cash and so on. Interestingly, it typically won’t include the value of any pensions.

In the 2021/22 tax year, the NRB is £325,000 and frozen here until 2026. So, if the value of your estate is below this amount when you pass away, no IHT will typically be due.

In addition to the nil-rate band, if you plan to pass your home to a child or grandchild you can make use of the additional “residence nil-rate band” (RNRB). This allows you to pass on up to £175,000 of property tax-free.

It’s useful to note that, if the value of your entire estate is more than £2 million, the RNRB is reduced by £1 for every £2 of value by which the estate value exceeds the £2 million threshold.

It’s also worth remembering that, if you’re married or in a civil partnership, you can pass on any unused allowance from the nil-rate band and residence nil-rate band to your partner. So, as a couple, you can usually pass on up to £1 million without IHT being due.

Your estate could increase while the threshold remains static

Because the value of your assets, such as your home and investments, could continue to rise in value while the NRB remains static until 2026, your estate could face a higher IHT liability. If your estate is not currently liable to the tax, this scenario may result in the tax being due against your estate for the first time.

With this in mind, speaking to a financial planner to confirm whether your estate might be liable to IHT could be a very shrewd move. So, let’s consider ways you could reduce or negate any liability, if it transpires your estate faces a tax charge.

1. Make gifts to loved ones

The good news is that the government allows you to make gifts every tax year that you can use to reduce the value of your estate. By reducing the amount of assets you have above the NRB, you reduce the amount of IHT your estate is liable for when you die.

If you reduce your estate to below your NRB threshold, your estate will not pay any IHT. In 2021/22, you could make the following gifts:

• A total of £3,000 that you can give to one person or split between many.
• An unlimited number of gifts of up to £250 to different beneficiaries.
• A £1,000 wedding gift to anyone, a £2,500 wedding gift to grandchildren, or a £5,000 wedding gift to children.
• Any amount can be given from your income as long as the gifts are regular, not from capital and do not reduce your standard of living.
• Unlimited lump sums known as a “potentially exempt transfer” (PET). If you give a PET, you must live for seven years before it falls outside your estate for tax purposes. If you don’t, your estate could be liable to a sliding scale of IHT, depending on other gifts you’ve made.

As you can see, if you plan properly, you could significantly reduce your exposure to IHT, allowing you to leave more money to loved ones.

2. Use Business Relief

As the government wants to help young and growing companies, it provides tax benefits for those who invest in them. One of those benefits is Business Relief (BR) or Business Property Relief (BPR), as it’s otherwise known.

If you invest in companies that qualify for BR, the money invested can typically be passed to beneficiaries IHT-free after you have held them for two years.

You can invest in qualifying shares using the Alternative Investment Market (AIM), Enterprise Initiative Schemes (EIS) and/or Venture Capital Trusts. That said, always speak to a financial planner before doing so to ensure they are right for you.

As they normally invest in fledgling companies, they are considered higher-risk, and so may not be right for your circumstances.

3. Leave your pension to loved ones

While pensions are typically used to provide an income in retirement, they also provide a lesser known IHT benefit.

As defined contribution pensions typically fall outside of your estate, you might be able to pass your pension pot on to beneficiaries without an IHT liability. With this in mind, you might want to consider living off savings and assets that will be liable to IHT before accessing your retirement fund.

Get in touch

If you fear your estate could be liable to an IHT charge and would like to discuss using gifts, Business Relief or a pension to potentially reduce it, get in touch as we’d be happy to talk. You can contact us by calling 0800 434 6337.

Please note:

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

Enterprise Initiative Schemes (EIS) and Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.

Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.

Tax levels and reliefs could change and the availability of tax reliefs will depend on individual circumstances.