6 positive ways to reduce Inheritance Tax if you’re caught by the threshold freeze

6 positive ways to reduce Inheritance Tax if you’re caught by the threshold freeze

While it may already seem like a long time ago now, in the beginning of 2021 the UK was in lockdown as it dealt with Covid.

At the time, the government was borrowing record amounts of money to prop up Britain’s economy, which, according to the Guardian, resulted in the UK’s total debt totalling £1.125 trillion.

Little wonder that in March 2021, the chancellor took steps to claw back some of this spending, and announced a freeze on several tax allowances and thresholds until 2026. Dubbed a “stealth tax” at the time, Canada Life claimed the move could generate an additional £2 billion for the government.

One threshold that will be affected by the 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. Read on to discover why your IHT liability may increase because of the freeze and six clever ways to potentially reduce it.

Inheritance Tax may be charged on all of your assets

If the value of your estate when you die is above a certain threshold, your estate will be liable to IHT. When you consider the tax is typically charged at 40%, you can see that it could significantly reduce the amount of wealth you leave to loved ones.

That said, everyone has an NRB, which means you can have £325,000 in your estate if you’re single before IHT is charged, or £650,000 if you’re married. You may also be eligible for the residence nil-rate band (RNRB), which could boost your threshold to £500,000 or £1 million respectively, although strict rules apply.

As the thresholds will now remain the same until 2026, your estate may be exposed to a greater IHT liability. This is because the value of your assets, such as property and investments, could increase while the threshold stays static.

So, let’s now consider six ways you could reduce or potentially negate an IHT liability.

1. You could use gifts to reduce liability to the tax

The government allows you to make several gifts every tax year that could help reduce the value of your estate and potential IHT liability. In 2022/23, you can give away the following amounts:

  • £3,000 to an individual. Alternatively, it can be split between however many people you like. In some situations, you can use unspent allowance from the previous year, meaning you can gift up to £6,000, or £12,000 as a married couple.
  • £250 to as many beneficiaries as you like.
  • Up to £5,000 as a wedding gift, depending on who the recipient is.

If you can reduce your estate to a level that’s below the NRB threshold using gifts, your estate will typically not be liable to IHT.

2. Make a potentially exempt transfer

If your estate faces a substantial IHT liability, the above gifts may not be enough to reduce it to below the threshold. If this is the case, consider a making a potentially exempt transfer (PET), which allows you to gift any amount you like to whoever you like.

The only stipulation is that you must live for seven years after it’s made. If you do not, the gift may be liable to a sliding scale of IHT, based on the number of years you lived for and other gifts you made.

3. Use gifts out of normal expenditure

This lesser-known way of gifting also allows you to give any amount to anyone you like. To be IHT-free the gifts must be made from income and not your capital, be made regularly (monthly, quarterly, or annually) and not reduce your standard of living.

4. Leave your pension pot to loved ones

Generally, pensions can be passed to beneficiaries IHT-free. Furthermore, depending on how old the pension holder is when they die, beneficiaries may be able to draw it without any tax liabilities whatsoever.

For this reason, you might want to live off savings and other assets that could be liable to IHT before accessing your pension pot.

5. Use investments that offer Business Relief

As the government wants to encourage investment into small and fledgling companies, it offers tax incentives to those who do so. One of those benefits is Business Relief (BR), which typically allows investments to be passed to beneficiaries without any liability to IHT.

You can usually invest in company shares that qualify for BR using the Alternative Investment Market (AIM) or Enterprise Initiative Scheme (EIS). In order to receive BR, you must own the shares for a minimum of two years.

Another advantage of these investments is that you can keep control of your wealth, and you may be able to generate an income from them. That said, BR-qualifying assets are typically seen as higher-risk, so care must always be taken if you are considering them.

6. Leave money to good causes

If you leave money to charities or good causes, it could reduce any IHT liability. If you leave more than 10% of your estate to charity, the rest of your taxable estate will typically pay IHT at 36% not 40% (2022/23).

Get in touch

Gifting and IHT is a complicated area and care must be taken to ensure you don’t accidentally expose your estate or beneficiaries to an unexpected tax liability.

If you fear your estate could be liable to an IHT charge and would like to discuss using gifts, Business Relief or your pension to 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.