Inheritance tax and passing wealth on

Inheritance tax is charged at forty per cent on the value of an estate above the available allowances. It is not a tax most people expect to pay, and for the large majority it is not one they will. But house prices across much of England have quietly pushed a lot of ordinary households into range, and the distinctive feature of this particular tax is that almost everything useful you can do about it has to be done years in advance.

That timing problem is the entire subject. By the time the estate is being administered, the options have gone. The planning window is now, while the person whose estate it is can still make decisions.

The allowances as they currently stand

The nil rate band is £325,000 per person. Anything below that passes free of inheritance tax. This figure has been fixed since 2009 and is currently frozen until at least April 2030, which means that every year of house price growth and general inflation pulls more estates into the charge without any announcement being made.

The residence nil rate band adds up to a further £175,000 where a main residence is left to direct descendants. Children, grandchildren, stepchildren and adopted children qualify. Nieces, nephews, siblings and friends do not, which catches a number of people out.

Transfers between spouses and civil partners are exempt without limit, and the survivor inherits whatever proportion of the deceased's allowances went unused. In practice this means a married couple can typically pass on £1,000,000 before any inheritance tax arises, being two nil rate bands of £325,000 and two residence bands of £175,000.

There is a catch in the residence band that deserves attention. It tapers away by £1 for every £2 by which the total estate exceeds £2,000,000. An estate of £2,350,000 has lost the residence band entirely. The effect is a marginal rate of sixty per cent on the slice of estate value between £2,000,000 and £2,350,000, which is the highest effective rate of tax in the British system. Anyone approaching that threshold should be looking at it deliberately rather than discovering it afterwards.

What counts as part of the estate

The estate includes rather more than people assume. Property, savings, investments, shares, vehicles, valuables, business interests and the proceeds of any life policy not written in trust all form part of it. Debts and reasonable funeral costs are deducted.

Life cover written in trust does not form part of the estate, which is why the trust paperwork matters. A £400,000 policy left in the estate adds £160,000 to the tax bill and pays out only after probate. The same policy in trust pays out to the named beneficiaries within weeks, free of inheritance tax, and can be used to settle the bill on everything else. The trust forms cost nothing and take twenty minutes. It is difficult to think of a better return on twenty minutes anywhere in personal finance.

The change coming in April 2027

Pensions have historically sat outside the estate for inheritance tax purposes, and that has made them a remarkably effective way to pass money down. Many people have been advised to spend other assets first and leave the pension untouched precisely because of this treatment.

From April 2027, unused pension funds are due to be brought within the scope of inheritance tax. This is a significant change and it undoes a good deal of planning that was entirely sensible under the old rules. Anyone whose strategy depends on pensions passing free of inheritance tax should be revisiting it now rather than in 2027.

The revised approach may involve drawing pension income earlier than previously planned and gifting the surplus, making better use of other allowances during lifetime, or reconsidering the order in which different pots are spent in retirement. The right answer depends on the shape of the estate, but the question needs asking well before the deadline.

Gifting, and the seven year rule

Giving money away during your lifetime is the most straightforward way to reduce an estate, and it comes with rules worth knowing precisely.

Several gifts are immediately exempt. The annual exemption allows £3,000 each tax year, and an unused allowance can be carried forward one year only, so a couple who have given nothing recently can move £12,000 between them straight away. Small gifts of up to £250 per person per year are exempt provided no other exemption has been used for that person. Wedding gifts are exempt up to £5,000 to a child, £2,500 to a grandchild and £1,000 to anyone else. Gifts to charities and UK political parties are exempt without limit.

The most underused exemption by a distance is regular gifts from surplus income. Payments made from income rather than capital, forming part of a normal pattern, and leaving the giver with enough income to maintain their usual standard of living, are immediately outside the estate with no upper limit and no seven year wait. A retired couple with pension income comfortably exceeding their spending can move substantial sums this way. The exemption is claimed by the executors after death, so it depends entirely on records: a simple annual note of income, expenditure and gifts made, kept with the will, is what makes the claim work.

Everything beyond the exemptions is a potentially exempt transfer. It leaves the estate completely if the giver survives seven years. Die within three years and the full forty per cent applies. Between three and seven years, taper relief reduces the tax charge on a sliding scale, though it is worth understanding that taper reduces the tax on the gift rather than the value of the gift, and it only bites once cumulative gifts exceed the nil rate band.

One trap worth flagging. A gift with reservation of benefit does not work. Giving the house to the children while continuing to live in it rent free leaves the property inside the estate regardless of whose name is on the deeds. Arrangements of this kind are common and are almost always ineffective.

Trusts

Trusts allow assets to be moved out of an estate while retaining a degree of control over who benefits and when. They are useful where beneficiaries are young, where a family situation is complicated, or where a spouse needs provision but the capital should ultimately pass to children from an earlier marriage.

They also carry their own tax regime, including an entry charge on amounts above the nil rate band, a periodic charge every ten years and an exit charge when capital leaves. They need trustees, accounts and occasionally tax returns. Trust work is done properly alongside a solicitor, and it is generally worth the cost only where the estate is substantial or the family circumstances genuinely call for the control a trust provides.

Insuring the liability instead of removing it

Not every estate should be reduced. Someone who needs their capital to fund a long retirement, or who simply does not want to give away control of it, has a different option. A whole of life policy written in trust, sized to the expected tax bill, pays out on death directly to the beneficiaries and gives them the cash to settle the liability.

This does not reduce the tax. It funds it, which solves the practical problem that inheritance tax is generally payable within six months of death while the assets that generated it may take a year to sell. Families forced to sell a house quickly to meet a deadline rarely get a good price for it. Joint life second death policies, which pay out when the second of a couple dies, are usually the appropriate structure and are considerably cheaper than two single policies.

Two things cost nothing and are forgotten more often than anything else in this area: putting life policies in trust, and keeping a written record of gifts made from surplus income.

Business and agricultural property

Business relief and agricultural relief can substantially reduce or remove the charge on qualifying trading businesses and farmland. Both have been subject to significant reform, with a cap introduced on the amount qualifying for full relief and a reduced rate applying above it. Anyone whose estate planning relies on these reliefs should be taking current advice rather than working from what was true a few years ago, because the position has genuinely changed.

Where to begin

The starting point is arithmetic rather than strategy. List everything you own, including property at current value, all pensions, investments, savings and any life policies not in trust. Deduct the mortgage and other debts. Subtract the allowances you expect to have available. If the result is comfortably negative, there is nothing to plan and you can stop.

If it is positive, multiply by forty per cent. That number is what your family will owe, and it is usually the point at which the conversation becomes concrete. From there the questions are about how much capital you genuinely need to keep, what you are comfortable giving away, and whether the remaining liability is better reduced or simply insured.

Wills, powers of attorney, expression of wish forms on pensions and trust documentation on life policies all need to be current and consistent with each other. A great deal of inheritance tax planning fails not because the strategy was wrong but because a nomination form from 2011 was never updated.

Randall Financial Solutions works alongside your solicitor and accountant on estate planning. The first conversation is at our expense and carries no obligation.

The Financial Conduct Authority does not regulate tax advice, trusts or will writing. Tax treatment depends on individual circumstances and may change in future. This article is general information and does not constitute personal advice.