A guide to inheritance planning in the UK

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Deciding how to pass on possessions after death is one of the most important choices many people will make. But it’s not always easy. One commonly asked question is, “How can I reduce inheritance tax?” In this guide, we’ll show why it can help to make an inheritance plan and the tax-efficient strategies that can help you leave behind more of your estate for your family.

The information provided here is for informational and educational purposes only and does not constitute financial advice. Please consult with a licensed financial adviser or professional before making any financial decisions. Your financial situation is unique, and the information provided may not be suitable for your specific circumstances. We are not liable for any financial decisions or actions you take based on this information.

When we talk about ‘inheritance planning’, we’re referring to strategies that help minimise the inheritance tax burden when passing on your estate. It can also involve managing your assets efficiently while you’re still alive, so you can leave more for your loved ones.

When someone passes away, everything they leave behind is known as their ‘estate’. Your estate might include:

• Your family home or other property
• Money in bank and savings accounts
• Personal possessions; household contents, cars, jewellery, and other valuables
• Life insurance policies
• Pensions
• Bonds
• Liabilities, such as mortgage, credit card, or loan balances

The main issue here is inheritance tax (IHT). Depending on the size of your estate, IHT can take a big chunk out of your estate when it’s shared out after your death. That’s why many people want to know how to plan for inheritance tax and keep more of their wealth for their loved ones.

Of course, inheritance planning is one thing, but it won’t mean much if you don’t have an estate plan detailing who you want to inherit each asset. Creating a will ensures that your wishes are followed, and it makes the whole transfer of wealth smoother once you’re gone. Without one, your possessions will be divided according to intestacy laws, typically going to your closest relatives. This can be more expensive for your family in the long run.

In the UK, you can pass on up to £325,000 of your estate without paying inheritance tax. This is known as the nil-rate band. Anything above that amount is taxed at 40%. So if your estate has a total value of less than £325,000, no inheritance tax is due. Plus, any unused allowance can be transferred to your spouse, meaning they could benefit from a £650,000 allowance when planning their inheritance.

There’s also an additional allowance called the residence nil-rate band, which can be used against the value of your home. The residence nil-rate band is currently £175,000 and only applies if you leave your main home to children or grandchildren. This means you can potentially benefit from a tax-free allowance of £500,000 per person.

However, if your estate is worth over £2 million, the residence nil-rate band gradually decreases, so not everyone will qualify for the full amount.

To see how it works, let’s say your estate includes:

• £150,000 in savings and possessions
• A home worth £400,000

Your total estate value is £550,000. Normally, this would exceed the £325,000 nil-rate band, leaving £225,000 potentially subject to IHT. But, if you leave your home to children or grandchildren, the residence nil-rate band adds an extra £175,000 to your tax-free allowance, bringing the total to £500,000.

In this case, only £50,000 of your estate would be taxed. Keep in mind that this inheritance plan is for illustrative purposes only, and real-life situations can be much more complex.

There are many different inheritance planning methods. As someone with an estate - big or small - you might firstly have to think about how much you have to pass down, including your home, savings, and valuable items. You can list each asset to come up with an overall value. By doing this, you can work out the potential inheritance tax due upon your death. You might then choose to gift money or assets while you’re alive to lower the overall value of your estate.

One of the most common strategies when making an inheritance plan is to gift money or assets while you’re still alive. There are several different forms of gifting that are completely exempt from inheritance tax, including:

• Gifts to your spouse or civil partner, regardless of the amount.
• Gifts worth up to £3,000 in cash or assets each tax year. This is your annual gift allowance, and if you don’t use it all, you can always carry it forward for one year.
• Smaller gifts of up to £250 per person per year, as long as the recipient hasn’t already received part of your £3,000 annual gift allowance.
• Wedding or civil partnership gifts. Tax-free gifts include £5,000 for your child, £2,500 for grandchildren, or £1,000 for other relatives or friends. The gift must be made before the ceremony, and the ceremony has to take place.
• Regular payments out of your income as part of your normal spending – as long as you can afford them, and they don’t impact your standard of living. You might like to make regular contributions to a children’s savings account or grandchildren’s savings account, for example.
• Gifts to charities, museums, universities, or similar organisations.
• Gifts to political parties, under certain conditions.

It’s important to keep clear records of these contributions as part of your inheritance plan to avoid landing your loved ones with an unexpected IHT bill when you die.

There are some drawbacks with gifting assets when planning for inheritance tax. The longer your money stays invested, the longer it has a chance to grow. And as soon as you start giving money away in small chunks, your children or grandchildren can spend it as they wish.

That said, there are ways to keep money invested until your heirs really need it, such as junior ISAs or SIPPs. You could contribute to these from the time they’re born, potentially building up a tidy sum for them by the time they reach adulthood.

If you do decide to give away assets early as part of your inheritance planning, you would need to be sure you won’t need those funds later. No one knows what’s round the corner, so it might be worth making sure you have a financial cushion to support you in retirement, such as regular income or a lump sum from a pension.

An alternative might be to place your money or other assets in a trust fund instead. This is where you transfer assets like cash, property, or investments to trustees, who manage them for the benefit of your chosen beneficiaries. The advantage is that you maintain control over how and when they are to be used.

Once in a trust, your assets no longer legally belong to you, which can reduce the inheritance tax liability on your estate. At the same time, you may lose access to these assets, so it’s important to carefully consider whether a trust is right for you. It might be a good idea to get financial advice on inheritance tax planning before making this decision.

Life insurance is another consideration when inheritance planning. Any payout your loved ones receive when you die counts as part of your estate and might therefore be subject to inheritance tax if the payout exceeds the tax-free threshold of £325,000.

However, a trust can also be used as a workaround. Placing your life insurance policy in a trust separates it from your estate. That means your beneficiaries will benefit from the full payout without it being reduced by inheritance tax. To set this up, speak with your life insurance provider and appoint someone to manage the trust.

Gifts you make are free from inheritance tax if you survive for seven years after giving them. However, if you pass away within seven years, their value could be added back into your estate for tax purposes.

Also, if you continue to benefit from an asset you gifted, for example, you live rent-free in a house that you gave away, it may still count as part of your estate, regardless of when you gave it away. These are called ‘gifts with reservation of benefit’.

The rules on gifting money or assets can be quite complex. For further information, read the government’s page on calculating inheritance tax on gifts.

Gifting your home to your children may trigger capital gains tax and progressive tax such as stamp duty, but it can sometimes be a way to reduce inheritance tax. Remember that if you pass the property to your spouse or civil partner, there’s no inheritance tax. However, gifting a property to children can have tax consequences.

Thanks to the residence nil-rate band, a single parent can currently pass on a property worth up to £175,000 to their children without inheritance tax. A widow can pass on property worth up to £350,000 without incurring tax (using the allowance from their deceased spouse or civil partner).

You can gift your home to a child while you’re alive, but there are key conditions:

1. You can’t continue to live in the property or benefit from it. If you start receiving rent, for example, the property will still be considered part of your estate for tax purposes.
2. You must survive for at least seven years after making the gift for it to be free of inheritance tax.

Given how complex inheritance tax planning can be, it might be helpful to get in contact with a financial adviser. They’ll be able to advise you based on your specific situation, and help you decide which strategy will best reduce the tax burden on your estate. Handing over your inheritance planning to someone else can take off some of the stress, and you’ll be confident that more of your estate goes to your family instead of the taxman.

A financial planning inheritance adviser or solicitor can also help you with estate planning and drafting a will, which will make the whole transfer of assets smoother. If you’re on the other side and inheriting an estate, professional advice can be equally helpful. Financial advisers can help with working out the value of an estate for wills and probate purposes.

Tax laws around inheritance can change frequently, and what works now may not apply in the future. With professional advice on inheritance tax planning, you can stay up to date and make informed decisions that ultimately save you money. While there’s a cost for their services, the upfront investment may be well worth it by keeping more of your money within the family down the line.

Funds in your bank accounts and savings accounts count towards the value of your estate. So why not start thinking about how you can get the most from them? By locking away some cash in a fixed rate bond, you can benefit from some of the most competitive rates around. Leave more for your loved ones by registering for a free Raisin UK Account. Once registered, the process is quick and easy. Simply select a savings account from a wide range of banks and building societies, apply to open an account, transfer your funds, and watch your savings grow!