Inheritance tax (IHT) changes could cost families up to £234,000 in additional taxes, but there are three key ways to mitigate this.
Rachel Reeves’ decision to freeze inheritance tax thresholds until 2030 will significantly impact how much wealth families can pass on tax-free.
By 2030, a couple could have passed on £1.1 million tax-free if the nil rate band had tracked inflation, analysis from AJ Bell shows. This figure could have reached almost £1.6 million if both the nil rate band and residence nil rate bands were indexed to prices.
Increasing both limits with inflation could have spared families up to £234,000 in IHT bills.
More families are finding themselves pulled into the inheritance tax net due to rising property values and savings.
Those affected are increasingly seeking ways to legally avoid the 40 per cent ‘death tax’ through careful advance planning.
Charlene Young, AJ Bell pensions and savings expert explained growing concerns about inheritance tax burdens.
Married couples with unused defined contribution pensions can still inherit the pension tax-free
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She said: “The government likes to tell us only 1 in 20 estates currently pays IHT, but their own figures show the amount they are raking in was already going up before the changes announced in the Budget.
“New rules (that are being consulted upon) for unspent pensions to get dragged into the IHT net from 2027, could result in higher bills for nearly 50,000 estates. That’s before the impact of an extra two-year freeze in thresholds will be felt.”
However, there are three key strategies families can employ to reduce their inheritance tax liability: making a will, using annual exemptions, and considering life insurance.
Making a will
Without a will, estates fall under intestacy rules, potentially leading to higher IHT bills and, in some cases, assets passing to the Crown.
Unmarried partners are particularly vulnerable, as they lack the same rights as married couples or those in civil partnerships under intestacy rules.
Regular will reviews are recommended to ensure they remain current and can include funeral wishes, with most funeral expenses being tax-deductible.
Young said: “If you have significant assets, estate planning using trusts can also help mitigate a tax bill. Trusts and taxation are complex areas, so you should seek professional advice from a solicitor and an independent financial adviser to avoid any costly mistakes.”
Annual exemptions and gifting allowances
Each tax year, individuals can give away £3,000 in total, either to one person or split between several recipients. Unused annual exemption can be carried forward for one year, while unlimited small gifts of up to £250 per person are permitted.
Wedding gifts also enjoy tax-free status: up to £5,000 for children, £2,500 for grandchildren, and £1,000 for others. Gifting can offer significant opportunities for tax-free wealth transfer.
Young added: “A powerful gifting allowance that is often missed is making gifts from excess income. You can set up regular gifts from your extra income without limit – for example to help towards grandchildren’s school fees or invest in their Junior ISA – provided you can show that they do not reduce your standard of living.
“The best way to evidence this is to keep records of your regular income and show that you’re not having to cut back on your normal spending to make them. The records will also be needed when it comes to administering your estate and claiming the exemption.”
Life insurance
This can present a practical solution for covering potential inheritance tax bills. Policies can be particularly useful for funding IHT liabilities or covering large gifts made within seven years of death.
Existing life insurance policies, including employer-provided coverage, should be reviewed as payouts may count towards the taxable estate.
Young concluded: “Writing policies in trust removes them from your estate and means your loved ones don’t have to wait for probate to make a claim.
“As IHT must normally be paid within six months to avoid interest and needs to be settled before probate is granted, insurance could make things easier for your loved ones and prevent assets having to be sold to help pay any bill.”