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Inheritance tax (IHT) stands at 40% on the value of your estate over £325,000 in the 2023-24 tax year. This could significantly undermine your goal to pass down wealth to your loved ones after you die. Fortunately, IHT can be mitigated with some careful planning. In this guide, our Burnley financial planners explain how inheritance tax works in 2023 and offer some ideas to reduce its impact on your estate. We hope this content is useful to you and please contact us if you want to discuss your financial plan with an experienced financial planner in Padiham.
What is UK inheritance tax?
UK inheritance tax (IHT) is levied on your “estate” (such as property and possessions) after you die. Those who are deemed UK-domiciled will have their worldwide estate – e.g. overseas property – potentially subject to this tax. Non-domiciled individuals (“non-doms”), conversely, are only subject to UK tax on their UK assets. Most UK citizens will fall into the former category. So, if you are currently living overseas or plan to retire abroad, be careful not to assume that you will not need to pay IHT when you die!
Which items are subject to UK inheritance tax?
Inheritance tax applies to a wide range of possessions and assets which you own such as cash savings, ISAs, property, your car(s) and household items such as furniture and jewellery. There are certain exemptions in 2023-23, however. These include pension pots and certain venture capital investments such as EIS shares held for a minimum of two years.
How much can you inherit in the UK before paying inheritance tax?
In 2023-24, an individual could potentially inherit £1m or even more from their parents without the estate needing to pay inheritance tax. This is partly due to a rule called the main residence nil rate band which lets someone pass down an extra £175,000 to a “direct descendant” (e.g. a child) without IHT if the latter inherits the family home.
Each individual is entitled to this, so two parents could “combine” them to potentially pass down an extra £350,000 to their children. When added to their respective IHT-free allowances (£325,000 each), a married couple’s estate could pass down £1m to children after their deaths. This assumes that no IHT allowances have yet been used and that other IHT-saving methods have not been used (discussed below).
Can I give my child £100,000 in the UK?
It is possible to give £100,000 to a son or daughter without inheritance tax, but it requires time and careful planning. Each tax year, you can give £3,000 in total away (to one person or more) without an IHT liability under your Annual Exemption. Your civil partner or spouse can also do this, potentially letting you give a combined £6,000 each year. Another idea is to let your child inherit your business. In 2023-24, certain business assets are exempt from IHT or face a lower rate due to Business Relief at 50% or 100%. A third idea is to give £100,000 to your child and hope that you survive the gift by 7 years. After this point, your gift is no longer subject to IHT (the “7-Year Rule”). However, if you die within that timeframe then the gift will face IHT – albeit maybe at a tapered rate. For instance, if you die 5-6 years after making the gift, then it will face a 16% rate rather than the typical 40%.
How do I avoid inheritance tax in Britain?
There are at least five main ways to avoid/reduce inheritance tax in Britain: making gifts, using IHT-free investment “vehicles”, passing down your family home, handing down a pension pot and using your spouse.
A pension is a well-known tool for retirement planning, yet it can also be a powerful means for planning your estate. In 2023-24, your beneficiaries can inherit any funds in your defined contribution pensions without facing IHT. This is partly why financial planners often advise that retirees focus on spending their ISA savings/investments earlier on rather than their pension, since the former cannot be passed down without IHT (unless investments qualify for Business Relief, such as AIM shares).
Planning far ahead can give you more flexibility here since your annual allowance will likely be restricted after you start accessing pension benefits. For instance, in 2023-24 you can put up to £60,000 into your pension(s) each year (or up to 100% of your earnings – whichever is lower) and still receive tax relief. However, if you trigger the Money Purchase Annual Allowance rules by, say, going into flexi-access drawdown, then your annual allowance is reduced to £10,000. Therefore, consider speaking with an adviser about your retirement plan and estate plan before retirement to ensure both work together optimally towards your goals.
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If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
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