12 min read

Products to look at when trying to reduce inheritance tax

Inheritance tax is no longer a sole concern of the ultra-wealthy. As property prices rise, an increasing number of ordinary families are finding themselves caught in the net; potentially reducing the amount of money left for their loved ones by tens of thousands of pounds.

Married couple looking at a laptop

Fortunately, there are a number of products and strategies at hand to reduce inheritance tax bills. But first you need to work out if you’re exposed.

How much inheritance tax might I have to pay?

Inheritance tax applies only to estates valued above a current threshold of £325,000. Anything higher gets taxed at a 40% rate. The estate includes all property, money and other possessions of someone who’s died.

Inheritance tax isn’t paid if assets are handed down to a legal spouse or partner, meaning the threshold for a couple can theoretically reach twice the threshold, or £650,000. The individual threshold is also higher if assets go to a person’s children. It’s now at £425,000, gradually rising to £500,000 by 2020.

All these numbers can seem really big. But don’t forget the value of the family home is included in the threshold calculation.

The average UK house was worth £226,000 in September, according to the latest Office of National Statistics figures. In London, it was £484,000 – and those numbers don’t even include other assets, such as cars.

Around 26,000 estates were liable to pay inheritance tax in the 2016 financial year, according to the Office of Budget Responsibility. That represents around 4.6% of the total.

Are there ways to reduce inheritance tax?

If you are worried about getting hit by inheritance tax, you may be relieved to hear there are things you can do about it. From gifting or donating money to looking into financial products such as a lifetime mortgage, the following are a few ways people use to help reduce their inheritance tax.

Give gifts or donate to charity

One popular way to reduce inheritance tax is to give to family and friends before passing away.

The government allows for an annual gift allowance all the way up until death, currently capped at £3,000 per year

Be warned, though: gifts worth more than that must be given seven years prior to death, otherwise inheritance tax still applies.

Gifts such as shares may also impose additional costs, like capital gains and income tax. And parents who still live in a property gifted to their children must pay them a market rent in order to avoid inheritance tax.

Alternatively, offerings to charity are completely free of inheritance tax, no matter how large. Giving an amount to charity worth at least 10% of an estate also reduces the inheritance tax rate to 36% from 40% on the rest.

To give an example, if you had an estate worth £425,000, you would have to pay 40% inheritance tax on the £100,000 that is above the £325,000 individual threshold, or £40,000. But if you gave £10,000 to charity, you would pay a reduced inheritance tax rate of 36% on £90,000 – or £33,400.

Set up a Trust

A trust is a legal entity that can be created by just about anyone. Transferring assets to a trust means you don’t actually own them anymore, potentially shielding them from at least some inheritance tax.

The person or organisation handed the assets – known as the trustee – has a responsibility to hold them on behalf of the beneficiaries, who could be children or grandchildren. These beneficiaries often won’t get access until they reach a certain age either, so this could also help contribute to their future.

Again, there are catches. The gift rule still applies, so if you die within seven years of transferring an asset to a trust, you could still be hit with inheritance tax. The tax rate gradually gets lower, though, depending on the time that’s passed between the transfer of the asset and death. If you don’t die within seven years, a 20% rate often still applies.

There’s many different types of trust and the laws  around each can be quite complex. So it’s important to consult with a lawyer or qualified financial adviser before setting one up.

Buy a business or invest in small companies

Shares in certain unlisted businesses, including many agricultural assets, are exempt from inheritance tax. They must be held, however, for two of the first five years after the date of death.

Shares listed on the Alternative Investment Market, or AIM, are also exempt because the government is keen to support small and upcoming businesses.

The downside of passing on such investments to loved ones is that they won’t necessarily get immediate access to their funds. They’ll also have to take on the risks associated with the business, which, naturally, are higher for the kind of less-established companies listed on the AIM.

Again, it’s very important to talk to a professional financial adviser about the best investment opportunities on offer to maximise returns and mitigate the risks.

Releasing equity from your home

Considering that the family home is often the biggest part of an estate, reducing its overall value can be a novel way of reducing an inheritance tax liability.

Equity release opportunities, such as lifetime mortgages or home reversion plans, allow people to unlock value that’s tied up in their home to spend on things like renovations, holidays or gifts to their relatives.

Money given to loved ones, however, is also still subject to inheritance tax if it’s given within a seven-year period before death. Of course, money spent on yourself is tax free!

Equity release products charge interest, currently at around 5.3%, that can accumulate into a large bill when the property is sold. Along with any fees that may be involved, the total sum will only be paid back in full once you die or move into a permanent care home, using the cash generated from the sale of your home.

It’s also important to remember that taking out a lifetime mortgage may lower the value of the property when it’s passed on to family members. A lifetime mortgage is essentially a loan taken out against the value of your property, so it’s important to weigh up the expected size of an interest bill compared to the size of a possible inheritance tax liability too. Finding out how much equity you could release can also help you make an informed decision.

And, as we’ve previously indicated, equity release products come in many shapes and sizes, all with an assortment of pros and cons. A financial adviser is the best person to help work out if they’re the best fit for you.


Written by Ross Kelly – Financial Journalist

Note: Whilst we take care to ensure Talking Finance content is accurate at the time of publication, individual circumstances can differ so please don’t rely on it when making financial decisions.