Inheritance tax (IHT) raised in the UK hit a record 5.2 billion during the last tax year. The dramatic increase over recent years owes much to rising property prices and frozen tax thresholds, but one could also argue that inadequate tax planning by individuals leaves their estates with a greater tax exposure than necessary.

Luckily, it doesn’t have to be that way. Much can be done to reduce the tax bill on your estate, but it does take a bit of planning. Leave it to the last minute and you may find that it could be too late to make a difference.

How Much IHT Do You Have to Pay?

When someone passes away, their entire estate becomes liable for IHT after the nil band threshold of £325,000 is exceeded. Married partners and civil partners can share their thresholds, meaning the nil rate band for the second death is £650,000.

What’s more, an additional residence nil-rate band was introduced since April 2017 that allows you to pass on your main residence to a direct descendant. The new extra tax allowance will rise incrementally over the next few years until 2020, at which point couples can leave up to £1 million to their children and grandchildren.

Everything above the nil rate bands is taxed at a flat rate of 40%.

Estate planning really comes into play when you consider the wide range of IHT reliefs and exemptions that are available. Working with a good legal adviser, it is highly recommended that you build a tailor made succession plan that is based on your individual circumstances and makes best use of all the allowance to preserve as much as your wealth as possible.

1. Make a Will

Did you know that know that two out of 3 people never get round to making a Will? A jaw dropping statistic considering the fact that your Last Will and Testament should be one of the cornerstones of estate planning. It’s one of the most important things you can put into place to ensure that your estate is distributed according to your wishes after you’ve gone.

Even if you have made a Will, ask yourself if it is up to date or may need reviewing. Perhaps your personal or financial circumstances have changed? Perhaps it was made before new tax changes came into effect?

2. Lifetime Gifting

Rather than waiting until you’re gone to pass on your wealth, why not make the most of lifetime gifting opportunities? In terms of the tax treatment, it can be more tax efficient to gift money while you are still alive. It can also have a transformative effect on your beneficiaries’ life, plus you’ll be around to see the effects of your generosity on their financial circumstances.

So, how much can you gift?

Every tax year, you’re able to give away £3,000 tax free, plus another £250 to any number of people. Wedding gifts to your children are tax free up to £5,000 per child. Grandparents are able to gift £2,500 tax free plus £1,000 to others. Gifts of any size to political parties or charities are tax free. What’s more, regular gifts made out of income that don’t affect your living standards will fall outside of IHT.

On top of the tax exempt gifts mentioned above, you can make further gifts that are potentially tax free as long as you survive for more than 7 years after making the gift. Tapered tax relief will be applied if you die before the full period.

3. Home Ownership

If you’re a married home owner, you probably own your property as joint tenants. This means that when you die your home will automatically pass to your partner. While this is a great solution for many couples, it doesn’t make sense for everyone.

Talk to your family lawyer about the benefits of changing the ownership structure of your home form joint tenants to tenants in common. That way, each partner owns a specified share of the property. This can then be passed on to someone other than their spouse after death, which may help to reduce both the IHT bill and long-term care costs.

4. Use Your Pension

Perhaps surprisingly, pensions are an extremely tax efficient way to pass on your wealth. If you die before 75 years of age, a money purchase pension will pay out as a lump sum or as a drawdown regular income to your beneficiary, entirely free of tax. Should do die after the age of 75 years, the beneficiaries’ ‘marginal income tax rate’ will apply.

With that in mind, it might be a good choice to fund your retirement income out of other investments you may have, keeping the value of your pension as high as possible for as long as possible. What’s more, as long as the funds are kept in drawdown, they will stay IHT free, meaning you can pass your pension to your children who, in turn, can pass it on further down the line.

5. Set Up a Trust

Trusts can be a very useful vehicle to minimise your IHT exposure – but you do need professional advice to navigate this complex subject to make sure your trust is as tax efficient as possible. A trust can help you to

  • Keep funds outside of the estate so that it is not subject to IHT
  • Protect your legacy to your surviving spouse in case s/he remarried
  • Protect your legacy to your children in case they get married/divorced, or from their own unwise financial decisions

6. Get Life Insurance

Life assurance is another valuable vehicle to help shield you from excessive IHT exposure. Make sure you take out a whole-of-life policy that lasts for as long as you live and, crucially, make sure the policy is written in trust and won’t form part of your estate when you die.

That way, the proceeds of the life insurance policy can be used to pay some or all of your IHT bill.

7. Investigate Business Relief

Finally, there are a number of shares listed on the Alternative Investment Market (AIM), a sub market of the London Stock Exchange that deals in smaller and less viable companies who float shares with a more flexible regulatory system. Any shares purchased will qualify for Business Relief after they’ve been held for 2 years, meaning they can be passed on free of IHT.

The same goes for Enterprise Investment Schemes (EIS) that invest in small, high risk, unquoted businesses. Expert financial advice and guidance is key before you embark on investments in this area, since although the tax advantages are substantial, there’s a high degree of risk involved.