It’s never too early to plan ahead to protect your financial future, especially when it comes to reducing the effects of Inheritance Tax (IHT). With certain methods in place, and some clever financial planning, you can make sure that your beneficiaries and loved ones benefit from the best possible outcome when you pass on your wealth. 

In this article, we’ll explain more about IHT planning and how you can minimise your IHT liabilities. 

Inheritance Tax explained

According to financial planning and investment services Close Brothers Asset Management, IHT is a tax on the estate of someone who has passed away. This includes savings, investments, real estate, life insurance pay-outs, and personal possessions. Debts and liabilities are subtracted from the total value of these assets.

For the tax year 2021/2022, the standard IHT rate is 40%, and is charged on the part of your estate that is above the tax-free threshold of £325,000. There’s normally no IHT to pay if you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club. However, any tax benefits will depend on your personal tax position, and rules are subject to change.

Writing a will

Your financial plan will depend on your personal situation, therefore it’s worth estimating the value of estate, as your first port of call. This can be part of estate and IHT planning with a financial adviser, or can be done independently using an online IHT calculator. 

The next important step to is write a will, within which you can appoint an executor — the person who will be responsible for carrying out your plan in the event of your death, and for paying the IHT to HMRC. An established will can mean that your assets are distributed according to your wishes, and help to avoid unexpected IHT liabilities. 

Gifting money during your lifetime 

One of the most straightforward ways to reduce the size of your taxable estate is through gifting money whilst you’re alive. Each tax year, you’re able to give away a certain amount, free of IHT, depending on which allowances you use. 

For 2021/2022, the Annual Exemption is a total of £3,000 worth of gifts each tax year, which are not added to the value of your estate. This can be gifted to one person, or split between several people. There’s also no IHT to pay on gifts between spouses or civil partners, as long as they live in the UK on a permanent basis.

Donating to charity 

Any money left to charity does not count towards your taxable estate, therefore can potentially reduce its value below the tax-free threshold, and help reduce your IHT bill. 

Plus, if you leave 10% or more of the net value of your estate to charity in your will, the IHT rate can be reduced from 40% to 36% on some assets. 

Establishing trusts 

Setting up a trust can also be an effective way to reduce your IHT, and one option to consider is a Discounted Gift Trust (DGT). A DGT acts as financial planning tool, allowing you to invest a sum of money in order to reduce the IHT you’ll pay, whilst providing an income of regular payments. 

Due to the nature of DGT, it can reduce potential IHT liability and allow for a lump sum to be passed on to your beneficiaries. 

Establishing a trust, and understanding the rules surrounding them, can be complex. When considering this option, it’s best to consult a financial adviser, to ensure that it’s a suitable approach for your personal circumstances. 

Using your pension

Lastly, making the most of a defined contribution pension can be another way to reduce your IHT bill. This is because your pension is not included in your taxable estate, and on most occasions, is free of IHT. However, depending on the age you are when you pass away, your beneficiaries may be subject to pay income tax on the money they inherit from your pension. 

It’s also worth noting that your pension is not usually covered by your will, and so as part of your plan, you will need to inform your pension provider of your nominated beneficiaries. 

Again, consulting with a pension or financial expert can ensure you’re using a pension wrapper correctly, and can pass on your savings to future generations in the most effective way. 


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