UK Inheritance Tax and how you can mitigate your liability

We are happy to have David Snelling from Charlton House Wealth Management (“CHWM”) to share their financial planning expertise through this article on a high-level overview of UK Inheritance Tax (IHT).

Regardless of your financial position and where you are based, if you have assets in the UK then IHT may well be payable on some of the value of your estate when you die.

This means it’s important that you’re aware of the details around IHT, and that you take steps to mitigate your liability before your death. Doing so means you can avoid leaving your family and beneficiaries with a large tax bill from Her Majesty’s Revenue and Customs (“HMRC”).

The latest HMRC figures show that IHT receipts between April 2022 and March 2023 were £7.1 billion, which was £1 billion higher than in the same period a year earlier.

Although fewer than 7% of estates were affected, it’s increasingly likely that the amount of IHT payable will continue to increase each year as more people become liable due to increasing property values, rising inflation, and the freezing of nil-rate band thresholds.

Read an outline of IHT below and how it’s calculated, together with some simple estate management steps you can take to help reduce your liability.

IHT is charged on the value of your estate

IHT is charged at 40% of the value of your estate above your nil-rate band (“NRB”).

The NRB for the 2023/24 tax year is £325,000 and it will remain at this level until 2028.

Additionally, if you will be passing on your main home to your direct descendants, you may also use the residence nil-rate band (RNRB) of £175,000 in the 2023/24 tax year before paying IHT. Again, this allowance is frozen until 2028.

Both of these thresholds apply to individuals and can be passed on to your surviving spouse or partner. This means that you could pass on up to £1 million without IHT being due.

However, it’s easy to see that if you have substantial assets, IHT can have a highly reductive effect on the amount that passes to your beneficiaries.

Your domicile will be an important factor in assessing your IHT liability

If you are a UK expat, it’s important to bear in mind that you may still be subject to IHT, as non- domiciled individuals have to pay the tax on their UK assets.

It’s also vital to remember that even non-doms can be “deemed” domicile for IHT purposes if you have lived in the UK for 15 out of the last 20 years.

In my experience, the issue of domicile is the one that most often trips up UK expats returning home. As a result, it’s worth you taking time to understand this and to seek expert advice on how best to manage it.

You can read CHWM’s handy guide that explains the issue in detail.

Read more: The new non-domicile laws that could impact on your Inheritance Tax planning

You can reduce your IHT liability by making gifts

One of the simplest ways to reduce the amount of IHT payable when you pass away is by gifting assets while you are still alive.

A common way of doing this is by using your annual gifting exemption.

In the 2023/24 tax year, both you and your spouse or partner can gift £3,000 each year and this amount will immediately fall outside the value of your estate for IHT purposes. You can carry forward any unused exemption for one tax year.

You can also make exempt gifts for weddings or civil ceremonies, and small gifts of up to £250 each to individuals during the tax year.

You should be aware that an individual can’t receive more than one type of exempt amount in a tax year.

You may also want to consider making donations to charity, or including charitable bequests in your will, as these can help reduce your IHT liability.

The “seven-year rule” applies to other assets you transfer

Beyond your annual gifting exemption you can, in theory, make gifts of unlimited value that will not be considered part of your estate for Inheritance Tax purposes, subject to you living more than seven years after making the gift. This is known as the “seven-year rule”.

As a result, such gifts are known as “potentially exempt transfers” (PETs) because of the potential that they may not be subject to IHT, providing you survive long enough.

You should note that any PETs must meet certain conditions and are subject to exemptions. For example, you cannot make a gift to a company.

If you decide to make a sizeable gift or series of gifts they will be considered first when calculating your IHT liability. Any PETs in excess of the NRB will be subject to taper relief based on the following

 

Years between the date of the gift and your death	IHT rate applicable
Less than 3	40%
3 to 4	32%
4 to 5	24%
5 to 6	16%
6 to 7	8%
7 or more	0%

 
As you’ll appreciate, the key message to draw from this is that if you’re considering making PETs to help reduce the amount of IHT chargeable to your estate, the sooner you start planning this the better.

You can also make regular gifts in some circumstances

If you make gifts out of your regular income – for example, payments to help elderly relatives – and they satisfy various conditions, then they are immediately exempt from IHT.

There are three key criteria:

• The gifts should form a regular pattern, rather than being one-off events
• The amount you gift must not affect your overall standard of living
• You must demonstrate they are from your actual income, rather than drawn from your accrued capital.

Read more: How to gift your assets to reduce your Inheritance Tax liability

You can use trusts to help mitigate your IHT liability

Putting some of your assets in trust is a common and effective way to reduce your IHT liability.

The structure of a trust can effectively remove assets from your control and, as a result, they may well not be included when your IHT liability is assessed.

There are many different types of trust, and the one you use will depend on certain factors, including:

• The type of asset you want to put in trust
• Who the trust ultimately benefits
• How, and when, you want your beneficiaries to have access to the assets you put in trust.

Because of their potentially complex nature, and the fact that once set up a trust could be impossible to dissolve, we would strongly recommend you seek expert advice before managing your assets in this way.

Read more: How using an excluded property trust could reduce your IHT liability and 3 common trusts used in Inheritance Tax planning

Some of your other assets are exempt from IHT

As you’ve already read, if you are a non-dom then all your overseas assets are exempt from IHT.

Additionally, any assets you hold that qualify for Business Relief can be passed on free from IHT when you die. You need to have held them for at least two years for this exemption to apply.

Finally, your UK pension assets are typically not subject to IHT. This potentially makes them an effective method of tax-efficiently passing your wealth to your beneficiaries.

The recent removal of the Lifetime Allowance, announced by the chancellor in the March Budget statement, could make your pension an even more attractive IHT planning option.

Why advice is essential

As you have probably realised from reading this article, expert financial advice is crucial when it comes to estate planning.

Mistakes or even simple oversights could be costly and result in your beneficiaries being faced with an unexpected – and unwelcome – tax bill.

Read more: Why DIY Inheritance Tax planning can be bad for your wealth

Get in touch

If reading this has given you food for thought and you’d like to talk about your estate planning, please get in touch. You can contact CHWM by email at [email protected], or, if you prefer to speak to them, you can reach them in the UK on +44 (0) 208 0044900 or in Hong Kong on +852 39039004.

Please note

This article is for information only. Please do not act based on anything you might read in this article.

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.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.