Can you avoid inheritance tax?
If your estate is sufficiently large, inheritance tax (IHT) may be charged after you pass away.
But there are ways you can cut your estate's tax bill and increase the tax-free amount being passed on to your heirs.
Below, we list some options for minimising your inheritance tax, including:
- Giving gifts
- Leaving money to charity
- Leaving your estate to a spouse
- Maximising your property allowance
- Considering equity release
- Taking out life insurance
- Using a deed of variation
We suggest you seek advice before making any gifts or taking any other actions towards planning your estate.
- Are you making a will? If you want support, you can make your will and have it reviewed by Which? Wills.
One of the simplest things you can do to avoid paying inheritance tax (IHT) is to spend your money, or give it away, during your lifetime. No tax is due on any gifts you give, as long as you live for seven years after giving them.
If you were to pass away within seven years of making the gift, the IHT amount may be reduced due to 'taper relief'.
Each tax year, you're allowed to give up to £3,000 worth of gifts, split between however many people you like - this is known as your 'annual exemption'. You're also allowed to make unlimited gifts of up to £250 to others, too - as long as you have not used another allowance on the same person.
You can also carry any unused annual exemption forward to the next tax year - but only for one tax year.
If you're off to a wedding, you can give up to £1,000 as a gift without needing to worry about inheritance tax. You can give more to relatives - £2,500 to grandchildren, and up to £5,000 to your children. For the gift to exempt from IHT, it must be made before the wedding, and the wedding must go ahead. Otherwise, the gift will be classed as a potentially exempt transfer.
If you make gifts above these thresholds, they will count as part of your estate and may be taxable if you don't survive for seven years after making them.
For more on tax-free gifts and PETs, see inheritance tax planning and tax-free gifts.
Any money you leave to a charity, providing it is registered in the UK, will always be free from inheritance tax. The same goes for gifts to political parties, or to local sports clubs.
What's more, if you leave more than 10% of your taxable estate to one of these groups in your will, the inheritance tax rate for the rest of your estate will fall from 40% to 36%.
The 10% only applies to the amount of your estate over the IHT allowance. So, for example, if you were leaving behind £425,000, you would benefit from the lower rate if you gave more than £10,000 (10% of the amount over £325,000).
Your spouse or civil partner will never have to pay tax on assets you leave them, regardless of the amount. Making the most of this in your will can save your family a small fortune.
When your spouse then passes away, they'll have inherited your unused IHT allowance, potentially allowing them to pass on up to £650,000 tax-free.
If they (or you) have remarried, then unused personal allowances can be added together and passed on - but only up to the value of one whole personal allowance (i.e. the most it can increase by is £325,000).
- Find out more: inheritance tax for couples
If you leave your home to your children or grandchildren in your will, then property allowances will increase your tax free threshold by £175,000 for the current 2022-23 tax year (for a total of £500,000).
For a married couple combining their allowance and leaving their home to their children or grandchildren, this means passing on estates of up to £1,000,000 completely free of IHT.
You can find out more in our guide to inheritance tax and property.
If all your wealth is tied up in your property, you may not be able to make use of gifts during your lifetime, or spend your wealth on yourself. To get around this, some people take out an equity release scheme.
It's important to remember that all this really does is reduce the assets you own, and increase the debts that will count against your estate. If you don't need to access cash from your property, giving assets away earlier is likely to be better for you.
How equity release schemes work
With these schemes, you can either borrow money against the value of your home (known as a lifetime mortgage), or sell part of your home at a reduced market rate, but remain living there throughout your life (a home reversion scheme).
The money you release can be passed on to your heirs, or you can spend it. Providing you survive any gifts by seven years, there will be no IHT to pay.
When you die
When you die, the value of your estate will be reduced, either by the mortgage debt (with a lifetime mortgage) or because only part of the value of your home will still belong to your estate (with a home reversion).
It sounds simple enough, but think carefully before going down this route. With lifetime mortgages, interest is ‘rolled up’ and your debt can swiftly grow.
For example, a £50,000 mortgage with an interest rate of 7% a year will have almost doubled to £98,358 within 10 years. You could end up owing more to your lender than you would have saved in IHT bills – either way, your heirs won’t benefit.
With the other route, you're selling off part of your home for less than its full value. So think about whether you're willing to let the bank take half of your home, just to stop HMRC getting a slice.
Consult a specialist
If you do think equity release might be for you, we recommend you always consult an independent financial adviser who specialises in equity release before going ahead.
- Find out more: our equity release guides
If you can’t reduce an IHT bill, you can insure against it. Life insurance is one of the simplest ways of covering an unwelcome bill, but unless you're relatively young and healthy, policies can be expensive.
Providing the policy is written into trust, the payout won't form part of your estate. You can find out more in our guide to inheritance tax and trusts.
HMRC treats the premiums paid to the insurance policy as a lifetime gift, if you pay them yourself. However, these can usually be covered by one of the tax-free exemptions – either the annual £3,000 exemption, or the ‘gifts out of normal income’ exemption.
- Find out more: What is life insurance?
A deed of variation allows your heirs to alter your will after your death so that, for example, part of the inheritance is re-directed to someone else.
They can draw up a deed of variation within two years of your death, but all affected beneficiaries under the will must agree to the variation.
This can be difficult in practice, especially if there are many beneficiaries.
As a general rule, it's better to review your will periodically so that your affairs are tax-efficient and don't require your heirs to make changes after your death.
This will simplify the probate process for your executor, and reduce the chances of your loved ones squabbling - which, sadly, can happen a lot.