Successful financial planning isn’t just about building wealth during your lifetime. It’s also about ensuring it passes efficiently to your family, rather than to the taxman, when you pass away. Few taxes prompt as much concern and discussion as Inheritance Tax (IHT). At 40%, it’s one of the highest in our tax system. Currently, IHT is charged at 40% on estates valued above the nil-rate band threshold of £325,000 per person. The residence nil-rate band provides an additional £175,000 allowance when you leave your home to direct descendants, potentially giving you up to £500,000 tax-free (or £1m for married couples and civil partners).
Despite these allowances, IHT receipts continue to climb as property values and investment portfolios grow. Many families face significant tax bills simply because they didn’t plan ahead.
The good news? With thoughtful planning, there are perfectly legitimate ways to reduce your potential IHT liability. This blog explores some practical strategies to help preserve more of your wealth for the next generation.
Understanding your potential IHT liability Before implementing any IHT planning strategies, you need to understand what your potential liability might be.
Your taxable estate typically includes your home, savings, investments, business interests and personal possessions. From this total, you can deduct any debts, including your mortgage.
Assets that might fall outside your estate include pensions (in most circumstances), agricultural property, woodland and heritage assets (subject to specific conditions). Assets left to your spouse or civil partner are also exempt from IHT. To calculate your potential IHT liability:
- Value your estate (all assets minus debts)
- Subtract your nil-rate band (£325,000)
- Subtract your residence nil-rate band if applicable (up to £175,000)
- Apply 40% tax to the remainder
For example, if your estate is worth £800,000 and you qualify for both allowances as a single person, the calculation would be:
- £800,000 – £325,000 – £175,000 = £300,000 taxable
- 40% of £300,000 = £120,000 IHT liability
Regularly valuing your estate is essential, especially after significant life events like marriage, divorce or receiving a large windfall, or purchasing assets. What might have been comfortably within your allowance a few years ago could now trigger a substantial tax bill.
Lifetime gifting
One of the most straightforward ways to reduce your IHT liability is by making gifts during your lifetime. Everyone has an annual exemption of £3,000, which you can give to anyone without IHT implications. If unused, this allowance can be carried forward for one year only. Couples can, therefore, potentially gift £12,000 to their children in the first year of planning, using both their current and previous year’s allowances.
You can also make small gifts of up to £250 per person to as many different people as you wish each tax year. These can’t be given to someone who’s already received your £3,000 annual exemption.
Gifts for weddings or civil partnerships enjoy additional exemptions:
- £5,000 from parents
- £2,500 from grandparents
- £1,000 from anyone else.
Regular gifts made from your normal expenditure (not capital) are exempt if they don’t reduce your standard of living. These can be useful if you have a higher income and want to establish a regular pattern of gifting. Larger gifts beyond these exemptions are known as Potentially Exempt Transfers. They become completely free from IHT if you survive for seven years after making them. If you die within this period, the tax due is reduced on a sliding scale after three years (known as taper relief).
To reduce the burden on your family when you die, keep records of all your gifts, including dates, amounts and recipients. Without proper documentation, your executors may struggle to claim the appropriate exemptions.
Trusts
A trust allows you to give away assets while retaining some control over when and how your beneficiaries receive them. Different types of trusts have different IHT implications.
Discretionary trusts give trustees complete flexibility about which beneficiaries receive what. When you place assets into a discretionary trust, it’s typically treated as a chargeable lifetime transfer, potentially triggering an immediate IHT charge if the value exceeds your nil-rate band. These trusts are also subject to periodic charges every ten years, as well as exit charges when assets leave the trust.
Life interest trusts, also called interest in possession trusts, give the right to income or enjoyment of an asset to one beneficiary during their lifetime, with the capital passing to others later. These can be useful for providing for a spouse while protecting the capital for children from a previous relationship. Trusts can be valuable tools for IHT planning, though recent tax changes have made them somewhat less advantageous than they were before. However, they do offer benefits beyond tax planning, including protecting your assets from a divorce settlement, providing for vulnerable beneficiaries, and ensuring financial support for younger family members until they’re mature enough to manage their own wealth.
The right trust structure depends on your family circumstances, the types of assets involved and your preferences regarding control and tax efficiency. Given the complex and changing nature of the way trusts are taxed, getting specialist advice from a chartered financial planner is essential.
Pensions Pensions have traditionally offered significant advantages for IHT planning, as they currently sit outside your estate for IHT purposes. However, important changes announced in the 2024 Autumn Budget will affect this from April 2027.
Under current rules, if you die before age 75, your beneficiaries can usually receive your remaining pension fund tax-free. After 75, they’ll pay Income Tax at their marginal rate when they draw from it, but the pension fund itself remains free from IHT.
But from 6 April 2027, all defined contribution pensions will become subject to IHT at the standard 40% rate. This represents a significant shift that could affect how your pension features in your estate planning strategy. An estimated 10,500 estates will pay IHT for the first time as a result of this rule change, with another 38,500 estates paying more IHT.
The change means that pension planning for IHT purposes becomes more complex for you. While your pension may still offer some advantages over other investments, it will no longer provide the complete IHT exemption that made it particularly attractive for transferring your wealth when you die. So, if you have substantial pension funds, you’ll need to reassess your strategy.
The previous approach of preserving your pension for inheritance while using your other assets first may become less beneficial, though your individual circumstances will vary significantly. Given these upcoming changes and their potential impact on your existing estate plan, getting professional advice is vital.
Life insurance
While life insurance won’t reduce your IHT liability, it can provide funds to pay the bill, helping your beneficiaries receive their inheritance without having to quickly sell any assets.
The crucial step is to write your life insurance policy in trust. This ensures the proceeds remain outside your estate for IHT purposes and go directly to your chosen beneficiaries without waiting for probate.
Whole-of-life policies are typically used for this purpose as they guarantee a payout upon death, rather than within a specified term. The cost increases with age, so starting this planning earlier usually means lower premiums.
This approach works particularly well for estates where the value is largely tied up in illiquid assets, like property or businesses, that the family wishes to retain intact.
Business and agricultural property relief
Business Property Relief (BPR) and Agricultural Property Relief (APR) have traditionally provided up to 100% relief from IHT on qualifying assets, making them among the most valuable reliefs available. However, significant changes announced in the Autumn Budget will affect these reliefs from April 2026.
Currently, qualifying business assets for BPR include your interest in an unquoted trading company, a controlling interest in a quoted trading company, and certain types of land, buildings or machinery used in your business. APR similarly provides relief on farming assets and land. Both reliefs generally require you to have owned the assets for at least two years before death, and you must meet various conditions regarding the nature of your business activities.
But from 6 April 2026, the Government will reform both reliefs. You’ll still receive 100% relief on the first £1m of combined agricultural and business property, but only 50% relief on values above this threshold.
For AIM investments, the changes are more significant. Currently, after holding AIM shares that qualify for BPR for two years, they become exempt from IHT. From April 2026, BPR on AIM shares will reduce from 100% to 50% in all circumstances, making this strategy less attractive for IHT planning. If you’re considering AIM investments for IHT planning, you’ll need to weigh the reduced tax benefits against the higher risk and volatility these investments carry compared to more mainstream investments.
Charitable giving
Leaving at least 10% of your net estate to charity reduces the IHT rate on the remainder from 40% to 36%. While you’re still giving money away, you’re directing more to causes you care about and less to HMRC.
The maths can be surprisingly favourable. For example, if your taxable estate (after exemptions and allowances) is £500,000 with no charitable donation, the IHT bill would be £200,000, leaving £300,000 for your family.
However, if you leave 10% (£50,000) to charity, your taxable estate becomes £450,000, which, when taxed at 36%, creates an IHT bill of £162,000. Your family would receive £288,000, plus the satisfaction of supporting your chosen charities.
So, establishing a charitable trust can create a lasting legacy while providing valuable tax benefits.
How can Heathcote Financial Planning help?
IHT planning isn’t a one-time exercise. As we’ve discussed above, tax rules can change, along with your circumstances and asset values. So, we recommend reviewing your IHT position at least every three to five years, after significant life events or substantial changes in your asset values, or after any changes to tax legislation.
While some IHT planning strategies are straightforward, others involve understanding the different tax regimes, how they interact, and what they mean for you. Getting specialist advice will help ensure your IHT planning is effective and avoids unintended consequences. Keeping your will up to date and ensuring your executors have clear records of your arrangements, particularly regarding gifts and trusts, will also help.
Starting your IHT planning early gives you more options and typically leads to better outcomes. Even taking small, consistent steps can, over time, significantly reduce your potential IHT liability while ensuring your wealth passes to those you care about most.
If you’d like to discuss your IHT options in more detail, our team at Heathcote Financial Planning can help you develop a tailored strategy that aligns with your broader financial goals. Book an appointment to see how we can help you.
Disclaimer
This article is intended for general information only and does not constitute personal financial or legal advice. Inheritance Tax (IHT) planning can be complex, and the strategies discussed may not be suitable for everyone. Tax treatment depends on individual circumstances and current legislation, which may be subject to change in future.
You should not take any action based on the information in this article without first seeking advice from a qualified financial planner or legal adviser. While we endeavour to ensure accuracy, Heathcote Financial Planning accepts no liability for any errors or omissions.
Heathcote Financial Planning is authorised and regulated by the Financial Conduct Authority.
Company registration: Heathcote Financial Planning is a trading style of The Mortgage and Protection Partnership Ltd, authorised and regulated by the Financial Conduct Authority under No: 612049. Registered address: Olympus House, Olympus Park, Quedgeley GL2 4NF. Company No: 08734287.