5 ways estate planning could reduce your loved ones’ Inheritance Tax bill

Last month, we looked at how the upcoming changes to pensions and Inheritance Tax (IHT) could affect your loved ones in the shape of a larger tax bill.

As a reminder, new legislation is due to come into force in April 2027 that will see unused pension pots included in an estate for IHT purposes for the first time.

However, carrying out some strategic estate planning now could help to mitigate your estate’s IHT liability. While you might not be able to eliminate IHT, careful planning could reduce the amount payable and help your loved ones manage a tax bill.

Frozen thresholds and new pension rules could see more estates liable for Inheritance Tax

The government estimates that as a result of the new pension and IHT rules:

• 10,500 estates will have an IHT liability where previously they would not.
• Approximately 38,500 estates will pay more IHT than would previously have been the case.
• The average IHT liability is expected to increase by around £34,000 when pension assets are included in the value of the estate.

Although the government has not raised the rate of IHT from 40%, the thresholds at which you start to pay – known as the nil-rate bands – have been frozen since 2009 and will remain at their current levels until 2031.

In 2026/27:

• The nil-rate band is £325,000. Any portion of your estate that exceeds this amount will typically be subject to IHT at 40%.
• The residence nil-rate band is £175,000, and you could be eligible if you leave your house to your direct descendants. Together with your nil-rate band, this allows you to leave a total of £500,000 without triggering an IHT charge.
• You can pass your entire estate to a spouse or civil partner without IHT, and they will inherit any unused nil-rate bands, giving you a combined potential allowance of £1 million.

As these thresholds remain frozen and the value of your assets potentially increases, a greater portion of your estate could exceed the nil-rate bands.

However, careful estate planning now may help you reduce the value of your estate and keep more of your wealth below the threshold, so your loved ones are not faced with such a high IHT bill.

There are several ways you can do this.

1. Use your gifting allowances

You have an annual allowance of up to £3,000 each tax year that will be free from IHT. You can also carry one unused year forward, potentially allowing you to gift £6,000 IHT-free in one year.

Small gifts of up to £250 for each recipient are not included in your estate for IHT purposes, and you can also give cash gifts for weddings or civil partnerships which could be free from IHT. You can gift up to £5,000 to your children, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else.

2. Gifting from surplus income

Another way to utilise gifting opportunities is to use the “gifting from surplus income” allowance.

For gifts to qualify to be removed from your estate, they must:

• Be made from surplus income and not capital
• Form part of a regular pattern of gifting
• Not impact your standard of living.

This could include paying for children’s or grandchildren’s school fees, or making regular contributions to ISAs or savings accounts for them.

It’s always a good idea to keep detailed records of these payments, in case your executors need to demonstrate this exemption to HMRC.

3. Making potentially exempt transfers

If you make a gift that falls outside the normal gifting allowances, this is known as a potentially exempt transfer (PET). If you live for seven years after making the gift, it will be completely free from IHT.

If you die within three years, then IHT will be applied at the full rate.

If you die between three and seven years after making the gift, taper relief will be applied, incrementally reducing the rate at which IHT is applied.

4. Gifting to charity

Another way to help reduce your estate’s value and potentially your loved ones’ IHT bill is to leave a gift to charity in your will. These are usually exempt from IHT, and if you leave at least 10% of your “baseline estate” to charity, you could reduce your IHT rate down from 40% to 36%.

Your baseline estate is the value of your assets after any IHT exemptions have been applied, but before the nil-rate bands are taken off.

It is important to note that pensions are not dealt with in your will, but by your pension provider. If you’d like to gift 10% of your estate, you will need to make sure they know that this includes 10% of any unused pension funds too; otherwise, you might not reduce your estate by enough to lower the IHT applicable.

5. Writing life insurance into trust

Another approach which could support your loved ones is to take out a life insurance policy. While this won’t reduce the IHT liability, they can use the payout to fund their IHT bill.

It is essential, however, that you write this policy into trust. This way, it will bypass your estate completely and proceeds will be paid to the trustees.

If you don’t write it into trust, it will become part of your estate and could actually increase the IHT liability.

Read our previous blog on this topic: ‘Pensions and Inheritance Tax: How the upcoming changes could affect your loved ones’ for more information.

Get in touch

Estate planning can be complex. Together, we can find the right approach to fit your circumstances. We’re always happy to help, so please email enquiries@integritasfp.co.uk or call 01283 777014 to find out more.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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

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.