Inheritance tax is arguably Britain’s most hated duty. But there are numerous ways around the divisive 40pc levy.
Many people are at risk of paying a large inheritance tax (IHT) bill each year, due to a key loophole slipping people’s minds.
We list some of the ways you can cut your tax bill below, looking to the rich and famous for inspiration. Some of the reliefs and exemptions used are common-sense strategies. Others are more elaborate. Crucially, all are entirely legal.
How to cut your inheritance tax bill in 2022
1. Give away gifts of up to £3,000 tax-free
Everyone in Britain can give away small gifts, such as Christmas or birthday presents, worth up to £3,000 tax-free.
This price cap is known as an annual exemption and can be carried forward to the following tax year, but only for one year.
Gifts can include wedding or civil ceremony presents of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, and £5,000 for a child), payments to help with another person’s living costs, such as an elderly relative or a children under 18, and Christmas or birthday presents. The £3,000 limit also covers gifts to charities and political parties.
2. Downsize and give your children the cash
Following Ronnie Corbett’s death at the end of March 2016, it emerged that he had sold his family home in 2003 for £1.27m, reportedly to raise cash that could be given to his children without paying inheritance tax.
He and his wife downsized into a local property worth around a fifth as much as their former home.
The buyer of the previous property, in which they had lived for more than 30 years, was reported saying the couple made the move in order to give money to their two grown-up children.
How it works
One of the main plans of inheritance tax is that it applies to assets you own at death – but it also applies to assets you have given away in the seven years before your death. This is to prevent “deathbed” giving as a way to avoid the tax.
Tax on assets above the tax-free threshold, which is £325,000 per person or twice that for married couples, £650,000, is applied at 40pc. In April 2017, individuals were able to claim an additional allowance of £100,000 for the first time to offset the sale of a family home on death, on top of their existing £325,000 inheritance tax exemption. This allowance now stands at £175,000, allowing a couple to spend on £1m estates tax-free.
As a result, if you are planning to give away large assets such as property, or very large sums of cash resulting from the sale of property, you need to live on after the gift for seven years in order for it to be free of tax . Within that seven-year period tax is applied at a sliding rate.
Where it might not work
You cannot give away an asset such as property and then continue to live in it without potentially running into “gift with reservation” rules.
You would need either to pay market rent to the new owners (probably your children) or find somewhere else to live.
Selling property and downsizing is, as well as a tax decision, also an investment decision: property might continue to grow in value more than cash.
In Ronnie Corbett’s case, it might have been better to continue owning the bigger property and pay inheritance tax than to cash in and move to a smaller property.
3. Use a deed of variation to pass inheritances on to your children
This is a useful trick that’s little understood and relatively little used. It involves the recipient of money or other assets in a will passing these assets straight on to another beneficiary.
This usually works where the first recipient already owns assets worth more than the £325,000 (£650,000 for a married couple) tax-free threshold.
When former MP Tony Benn died in 2014 it emerged that the ownership of his valuable home in west London had been split on the death of his wife in 2000, with the couple’s children taking part-ownership.
why? One possible answer is that the aim was to reduce inheritance tax.
How it would have worked
In 2000, the tax-free allowance was £234,000 per person (rather than £325,000 as today) but crucially in 2000 you could not add a married couple’s individual allowances together, applying both to the death of the second spouse.
That generous extension was introduced only in 2007.
If Mrs Benn had simply bequeathed her share to her husband no tax would have been payable by him, as assets passing between married couples are exempt. But, crucially, he would have had more assets to bequeath to his children of him at his own future death of him – and the benefit of his wife’s personal IHT allowance would have been squandered.
The Benns may have carefully planned ahead and constructed a will in which her share went to the heirs on her death.
But imagine they did not. Say, just like most couples, Mrs Benn had left everything to her husband de ella after all. With the advice of a solicitor, Mr Benn would still be able to draw up a “deed of variation” in which he passed a proportion of the property directly to his beneficiaries.
This would mean her share of the home never entered her estate and her allowance was fully used, as if she had given the property directly to her heirs in her will.
A deed of variation along these lines requires the consent of every beneficiary mentioned in the first will, and needs to be completed within two years of the person’s death.
Where it might and might not work
As with the first, this strategy runs into potential difficulty where – as with the Benns – it is used to pass on property wealth.
Mr Benn would have had to pay a market rent to the owners of his late wife’s portion of the property, because he continued to live on in the house until his own death.
A clearer example of how deeds of variation can work is this: say an elderly person (such as a grandparent) dies and his or her beneficiaries (usually the children) are already well off enough to face death duties on their own assets.
The grandparents’ will can be changed via a variation to pass the assets straight on to other heirs (the grandchildren). That way the money skips the parents’ estate altogether.
4. Invest in ‘Aim’ shares and other IHT-proof assets
To encourage long-term investment in certain assets, the Government grants them exemption from inheritance tax, as long as certain criteria are met. This has given rise to portfolios of IHT-proof assets being built.
Notable among these was the “Aim share Isa portfolio” created by the late Jim Slater, a celebrated investor and author, who wrote about the portfolio in his regular columns for Telegraph Money.
“Aim” shares are those listed on the junior Alternative Investment Market in London.
Some of these firms are very small. While they may grow into fantastically valuable businesses, they could also fail, losing shareholders everything.
Not all Aim shares escape IHT. They have to be held for two years and held directly by the individual – they cannot be held in a fund such as a unit trust.
This is because the relief – known as “business property relief” – was originally intended to prevent those inheriting a business from having to sell assets to pay the tax. It requires a direct stake in a business.
Companies qualify only if they meet certain criteria. But there’s no definitive list to check and the taxman makes a judgment on whether a company is exempt only when the tax is due.
5. Write a will – failure to do so could leave you with an avoidable IHT bill
Where there is no will, assets are handed out according to a set of rules laid down in legislation. This could land you with a tax bill.
This may have happened when Rik Mayall, the comedian and actor behind nasty MP Alan B’Stard, failed to have a valid will in place when he died unexpectedly in June 2014.
The probate records revealed the lack of a will relating to his £1.2m estate.
Where – as possibly the case with Rik Mayall – a married parent dies without a will, a portion of their assets go straight to their children, triggering a potential tax liability when the assets exceed the threshold.
Had a will been written, more or all of the assets could have been given to the surviving spouse, leaving time in which to give them away or make other arrangements to reduce the eventual bill at the death of the second partner.
6. Capital gains tax: hang on to your assets and die owning them
If people sell valuable assets or investments other than their family home or Isas, capital gains tax is often due on the profits they’ve made.
In the past, families have decided it is better to pay this and give the money to their heirs ahead of their death in order to avoid inheritance tax.
But the “family home allowance”, which extends the overall inheritance tax allowance for couples up to £1m from 2020, has given a bit of scope to avoid both IHT and CGT.
Capital gains tax liabilities die with you. This means the new higher £1m inheritance tax threshold has opened up new opportunities for cutting not just death duties but CGT bills too.
Not everyone will qualify for the additional allowance. It will not be available to those without children, or to many business owners. Estates worth more than £2m will also have their allowance tapered away.
7. Stuff your pension full of cash – but don’t spend it
This is easier said than done, but it’s worth knowing about. Money inside a pension can be bequeathed IHT-free.
So for those with different sources of wealth, it could pay to spend non-pension income in retirement while leaving your pension pot intact.
Where there are other major assets that would attract IHT, such as second homes or shares or business assets, it might also make sense to sell these and live off the proceeds while the pension is untouched.
But there are likely to be other tax consequences of your actions (such as capital gains tax on the sale of your investments). And the maximum amount you can save into a pension is also now reduced to just over £1m – so this method has its limitations.
This article is kept updated with the latest advice.