7 Jun 2023


Inheritance tax 

aka iceberg tax

Here at FiveWays we sometimes refer to inheritance tax (IHT) as an iceberg tax. You don’t always see it coming, but there can be a whole lot of trouble hidden beneath the surface.

The first rule of IHT is that you do not usually have to pay it if your estate is worth less than £325,000. In this case, IHT is not something you need to worry about. Yet with frozen inheritance tax thresholds and rising property prices, more of us are at risk of being clobbered by IHT.

The second rule of IHT is that married couples benefit from special exemptions. But be warned: these exemptions only apply if you have tied the knot. Unmarried couples – even cohabiting partners – do not enjoy the same perks. Current IHT rules stipulate that on the first death any assets in excess of £325,000 will be taxed at 40 per cent. Therefore there is a real risk that cohabiting couples end up being double-taxed - paying inheritance tax on both the first death and again on the second.

This really happens and FiveWays have dealt with referred cases like it recently.

What you need to know

The most significant asset from an IHT perspective is a valuable house. That said, how much your final IHT bill will be depends on whether or not you leave your home to direct descendants, such as children or grandchildren. Since 2015, if you pass on your inheritance to children or grandchildren you can take advantage of something called the ‘residential nil rate band’.

This is an additional allowance of £175,000 you will receive on top of the existing £325,000 IHT allowance.

This means inheritance tax might not be due on the first £500,000 of your estate (£325,000 + £175,000) if you leave your home to your children or grandchildren.

IHT is in certain circumstances a voluntary tax, meaning you can mitigate it if you want to. Here at FiveWays you can potentially reduce your IHT bill:

Spend the Money

The simplest thing you can do is spend your money. Fritter it away however you like; as long as you’re below £325,000 by the time you die, there isn’t going to be an inheritance tax bill.

Gift it

There is more than one way to gift money.

You can give £3,000 away each tax year IHT-free. The first £3,000 given away each tax year is completely ignored as part of your estate and therefore not subject to inheritance tax if you die.

Gifts of up to £250 per person each tax year are also excluded from inheritance tax (and are not counted towards the £3,000 annual gift exemption).

Another thing you might consider is to gift the money but retain control of it by putting it into a trust. That way the beneficiary won’t have access to it until later on (let’s say when they are a bit older if it’s a teenager).

If someone you know is getting married, you can give them gifts without those gifts being subject to inheritance tax. The limits are: £5,000 for a gift from a parent, £2,500 from a grandparent, £1,000 from anyone else.

IHT will usually apply on gifts if you give away more than £325,000 in the seven years before you die.

Make a Charitable Donation

Donations to charity made as part of your will are not subject to inheritance tax. Where the donation is equivalent to at least 10 per cent of your estate, any inheritance tax payable is reduced from 40 per cent to 36 per cent.

Take out a Life Insurance Policy

A life insurance policy provides a lump sum to your loved ones when you die. If the total value of your estate is more than £325,000, the proceeds of your insurance payout can be used to pay any inheritance tax due, protecting the value of your estate.

There’s usually no income or capital gains tax to pay on the proceeds of a life insurance policy that is ‘written in trust’. This just means your policy is placed inside a legal entity called ‘trust’.

In setting up a trust, you are still responsible for paying the premiums, however the proceeds are not included within your estate if there is a claim. In other words, they are not part of the IHT equation. They are also not subject to probate, which means they can be distributed more quickly.

Put it into a Pension

Pension pots are not subject to IHT when you die, therefore they are an effective IHT vehicle. Your family can inherit any remaining money in your pension pot that you haven’t spent or converted to an annuity. An annuity is a guaranteed income for life (rather than a pot of money) – and by definition, an income for life ends when you die. This means it can’t be passed on. However, you can arrange for your partner to continue receiving an income from your annuity after you are gone.

Business Relief

There are more complex, expensive, and higher risk ways to mitigate or reduce an IHT bill, and these involve the use of various business asset reliefs. These can be highly effective and give relief from IHT potentially after only 2 years. As business assets though very careful assessment and detailed analysis is needed before making use of them.

Do you want to plan effectively for inheritance tax?

Feel free to reach out to one of our specialist advisors to talk through any of the tax changes announced in the recent budget or how to plan effectively for inheritance tax.

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