How to mitigate IHT – What options are there?

IHT receipts in the UK hit a record high of £7.5 billion in the 2023-24 tax year; an increase of £400 million compared with the previous year. This trend is expected to continue as the government implements changes to raise more funds for the Treasury. For example, changes to the ‘non dom’ rules relating to IHT come into effect in April 2025; business property relief reductions are coming in 2026; and IHT payable on unused pension balances (coming in 2027) will all increase net revenues for the Treasury.

In the meantime, it is still possible to mitigate the effects of inheritance tax (IHT) in the UK. Taxpayers wanting to reduce the tax payable on their estate on death can combine tax allowances and strategic gifting. Here are some of the most effective strategies to consider, each supported by examples and scenarios:

1. Maximise your tax-free IHT allowances

Most importantly, make sure you are using all the available allowances with the Nil-Rate Band and Residence Nil-Rate Band.

Every individual has a £325,000 IHT-free allowance, known as the Nil-Rate Band. For married couples and civil partners, any unused portions of their IHT-free allowance on their death will automatically transfer to the survivor, doubling their tax free threshold to £650,000.

There is also a Residence Nil-Rate Band which is available to property owners. This allows someone to pass on a main residence to their direct descendants (either children or grandchildren) and it adds an £175,000 onto the main nil-rate allowance. It makes the total tax-free threshold worth £500,000 per individual or £1 million per couple. However note this allowance is only available in full where the total estate on the second death does not exceed £2m.

Here’s how it can work in practice:
On the first death of a couple, the estate of the first deceased is left to the surviving spouse. This is covered by the spouse exemption, leaving the allowances available to the first deceased unused. On the second death, the entire estate of £975,000, including their £900,000 home, is left to the couple’s children. The combined thresholds of £1 million cover the estate, resulting in no IHT payable.

If the entire estate exceeded £1m, IHT would be payable on the excess at the rate of 40%.

If however the entire estate exceeded £2m, the Residence Nil-Rate Bands would be lost, and IHT would be payable on the amount of the estate exceeding £650,000.

2. Make use of strategic gifting

Potentially Exempt Transfers (PETs)

In the example above of an estate exceeding £2m, the couple might want to consider lifetime gifts to reduce the estate below £2m.

Any gifts that are made during lifetime can be IHT-free if the donor survives for 7 years after the gift is made. This is a potentially exempt transfer (PET). On the death of the donor within 7 years of making the gift, it becomes a failed PET the value at the time of making the gift is included in the estate for the purposes of calculating the IHT liability.

If the failed PET attracts an IHT liability (i.e. if it exceeds the Nil Rate Band available), taper relief will apply to reduce the rate of tax payable on death occurring within 3 to 7 years or making the gift.

Taper relief is calculated as follows:

Gifts made between 0 – 3 years before death – 40% tax payable
Gifts made between 3 – 4 years before death – 32% tax payable
Gifts made between 4 – 5 years before death – 24% tax payable
Gifts made between 5 – 6 years before death – 16% tax payable
Gifts made between 6 – 7 years before death – 8% tax payable.

Annual gift allowances

In addition to making larger potentially exempt transfers it is possible to make tax free gifts that are considered to be outside the donor’s estate immediately. These are as follows:

• Standard £3,000 gift allowance per donor per year. It is also possible to carry forward an unused allowance by one year and make gifts of £6,000 in a tax year, which will fall outside the estate immediately.
• Small gifts of up to £250 per donee per year can be made with no limit on the number of recipients.
• Wedding gifts can be made to relatives, with gifts of up to £5,000 for children or £2,500 for grandchildren falling outside the estate immediately.

3. Pension planning for IHT

Until 5 April 2027, pension assets are exempt from IHT. However on death after the age of 75, the beneficiaries will pay income tax on the withdrawal of funds. On death before age 75, the beneficiaries have no tax liability, either IHT or income tax, hence pensions have been for many, an integral part of their IHT planning.

From 6 April 2027 however, pension assets will be included as part of a deceased’s estate and will attract IHT. If death occurs after the age of 75, the beneficiaries will still pay income tax on the withdrawal of funds, creating a double tax liability.

This is obviously a big change and needs to be included in IHT planning strategies.

Next steps: What are the key IHT planning actions to take before 6 April 2026 and 2027?

• Consider lifetime gifts of cash wherever practicable (note that if gifting assets rather than cash, advice should be taken in relation to the capital gains tax effects);
• Consider the viability of a trust for gifts, to protect family assets and to potentially hold over capital gains applying to assets;
• Use annual allowances – £3,000 (plus last year’s unused £3,000 if applicable) and £250 per recipient for smaller gifts;
• Depending on the size of the estate, review property plans to ensure the residence nil rate band can be claimed on death;
• Consider drawing on pension assets in priority to other assets, taking into account both IHT and income tax;

Relatively simple strategies can effectively reduce IHT liabilities and preserve more wealth for future generations.

If you would like more specific inheritance tax advice, contact us via partners@rjp.co.uk.