Passing wealth to your loved ones may be a priority for you when creating your financial plan. If this is the case, you might be concerned about Inheritance Tax (IHT) as the number of families facing a bill is on the rise.
Indeed, Professional Adviser reports that the government raised £701 million from IHT in May 2024 – an increase of £200 million compared to the same period the previous year.
Additionally, the government has hinted that there may be tax increases in the near future, and there is speculation that they could target IHT. Fortunately, there are several ways to potentially reduce the IHT that your family pays.
Read on to learn about five useful exemptions that could cut an IHT bill.
1. The gifting annual exemption
In the 2024/25 tax year, you can pass on up to £325,000 without triggering an IHT charge. This is known as your “nil-rate band”. You may also benefit from an additional £175,000 “residence nil-rate band” when passing your main home to a direct descendant such as a child or grandchild.
Further to this, you can pass your entire estate to a spouse or civil partner without IHT, and they inherit your unused nil-rate bands. This means that, collectively, you could pass on up to £1 million IHT-free.
However, any wealth that exceeds your nil-rate bands may be subject to IHT.
The good news is you can use your “gifting annual exemption” to pass wealth on while you’re alive and potentially reduce the IHT your family pays in the future.
In the 2024/25 tax year, you can gift up to £3,000, which automatically falls outside your estate for IHT purposes. Each person has their own gifting exemption so, as a couple, you could gift up to £6,000 a year.
Additionally, you can gift £5,000 to a child, £2,500 to a grandchild, or £1,000 to anybody else for a wedding.
These gifts may be an effective way to reduce the size of your estate and potentially mitigate IHT.
2. Potentially exempt transfers
If you’ve already used your gifting annual exemption and you make further gifts to your loved ones, these are known as “potentially exempt transfers”.
These gifts may still fall outside of your estate for IHT purposes, but only if you survive for seven years after transferring the wealth.
If you pass away within seven years, your family may still pay some IHT. The rate they pay depends on how long you live for after making the gift.
For example, they could pay:
- 40% if you live for less than three years
- 32% if you live for three to four years
- 24% if you live for four to five years
- 16% if you live for five to six years
- 8% if you live for more than six years but less than seven.
You may be able to use potentially exempt transfers to gift more than your annual exemption.
3. Gifts to charities or sports teams
You may want to use some of your wealth to support causes close to your heart, and this might have some IHT planning benefits too.
This is because all gifts to charities or “community amateur sports clubs” (CASCs) are free from IHT, whether you make them while alive or leave wealth behind when you pass away.
To qualify as a CASC, a club must be:
- Open to the whole community
- Organised on an amateur basis
- Primarily designed for the provision of sports facilities
- Supervised by managers who are “fit and proper persons”.
Additionally, if you gift at least 10% of your entire estate to charity in your will, your family may pay IHT at a reduced rate of 36% instead of 40%.
4. The gifts from income rule
The “gifts from income” rule is a useful way to make regular payments that fall outside your estate, and don’t count towards your other IHT exemptions. However, these payments must meet certain criteria if they are to be free of IHT.
The payments must:
- Be regular
- Be paid from your regular income, not from capital or savings
- Not affect your usual standard of living.
You might use this exemption to help loved ones manage increased expenses during the cost of living crisis, for example. Alternatively, your loved ones could use the payments to contribute to their savings and investments for the future.
5. The “small gifts rule”
Finally, you may be able to make further payments using the “small gifts rule”. This exemption allows you to make gifts of up to £250 to as many people as you like each year. However, these payments are only exempt from IHT if you haven’t used any of your other exemptions or allowances on the recipient.
You can also pass wealth in your pensions to loved ones without Inheritance Tax
Using various exemptions could help you reduce the IHT that your family pays when you pass away. However, you may also want to explore other options for passing wealth to your loved ones, such as your pensions.
Wealth in your pensions doesn’t count towards your estate for IHT purposes. As such, you may want to draw from other sources, such as an ISA, to fund your lifestyle in retirement and leave as much wealth as possible in your pensions. This means you can potentially pass more wealth to your loved ones tax-efficiently.
However, if you pass away after 75, your beneficiaries may pay Income Tax at their marginal rate when they draw from the inherited pension. So, it could be useful to seek professional advice to explore the most tax-efficient estate planning options.
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If you’re concerned about the IHT your family may pay in the future, we can help you mitigate a bill.
Please get in touch to find out how our team of VouchedFor Top Rated planners could assist you today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients 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.
The Financial Conduct Authority does not regulate estate planning or tax planning.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.