This article was uploaded on May 17, 2020, and will be updated regularly.
This article will explain some legal tax-efficient ways you can avoid UK inheritance tax.
This is a question I get asked about a lot, especially from British expat clients living outside of the UK.
Tax laws, however, may change in the future, and you should always consult with a qualified tax advisors in the UK which we aren’t.
In other words, this article should be considered as a basic guide, and not formal tax advice.
If you have any questions, or you are interested in tax-efficient investments as a UK expat living overseas, you can contact me on this form.
A quick note on legal avoidance
We are living in a world of transparency now. Tax authorities share data globally.
It might be imperfect and inefficient, but it is much more open than before.
So even if we avoid any moral arguments about the need to do everything “properly”, it is in everybody’s self-interest to only look at legal ways to minimise taxes and not illegally evade tax responsibilities.
Whilst the media put out a lot of misleading information about evasion and avoidance being the same thing, in reality avoiding or reducing your taxes is just another form of legal tax minimisation like opening up a tax-efficient investment account.
This article will therefore discuss some legal ways to lower your tax burden.
UK expats and British people living overseas.
It is beyond the scope of this article to go into details about non-British people living in the UK, British people living overseas (UK expats) and non-domiciled residents living in the UK.
However, it is important to remember that:
- In these cases, tax law is even more complicated than for a British person living in the UK
- Your residency, tax residency, citizenship and domicile aren’t always the same thing. The UK has some rules, for example, whereby your domicile can sometimes be linked to your dad’s side if he is non-British, even if you were born in the UK
- This makes seeking advice even more important. Often you need to establish beyond reasonable doubt where your domicile, residency and tax residency is.
Top 17 ways to avoid the IHT tax in the UK
After speaking about some basic things, let’s have a quick overview of inheritance taxes in the UK, and speak about some ways to reduce or avoid it.
1st case in the definition: Overview of the IHT tax in the UK
Inheritance tax itself was introduced by the government in 1986 to replace a tax which at the time was called capital transfer tax.
The Inheritance Tax is applicable to funds in your estate property, money and assets of someone who just died.
In 2020 it is a set at a rate of 40%, but, there is normally no Inheritance Tax to pay if either:
- the value of your estate is under the £325,000 threshold (this is also called nil band rate), or
- you leave the exceeding sum over the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club.
If the value of the estate is under the threshold you will still have to report it to HMRC.
If you decide to give away your home to your children (including adopted children, stepchildren, foster or grandchildren) your threshold will increase to £500,000.
If you happen to be married or in a civil partnership and the value of your estate is less than your threshold, any unused threshold can be added to your partner’s threshold the moment you die. Therefore, the combined thresholds can reach up to £1,000,000.
However, if your estate is worth more than the thresholds above, then you will pay tax at 40% on anything above the threshold amount.
In the 2015 Summer Budget, a new main residence transferable allowance was disclosed which gradually increases from £100,000 in 2017 to £175,000 per person by 2020/2021 which may grant people to bypass inheritance tax on property. So, for 2020/21, the main residence transferable alimony is £175,000. This sum is in addition to the nil-rate IHT threshold.
The OTS advises that the tax-free allowance is allocated in chronological order. If you offer £325,000 to your son in one year, and then the same amount to your daughter the following year, your son would benefit from the full nil-band allowance, leaving your daughter with a potential tax-bill.
If you find yourself having to pay it, you can negotiate it and pay in instalments, but basically otherwise it is normally six months after the probate has been granted.
2nd Way, Take Out Life Insurance
Taking out life insurance and directing the money into trust still does not directly reduce the amount of inheritance tax you will have to pay. However, it will make it easier for your surviving family members to pay the bill.
The payout may prevent them from selling the family home, for example.
3rd Way, Give Away Your Business Assets Before You Die
Of course, there is no need to wait until you die to distribute your belongings. As you become older, you are likely to find that many of the assets that you have accumulated are not needed and this could be the best moment to pass them on.
You should seek legal representation to make sure that your assets are distributed in a fair manner and that there are as few conflicts as possible. Take the time to work out how much you need to live on and consider giving everything else away to your close friends and relatives.
4th Way, Leave Some Money To Charity Organizations
If you leave all of your Estate to a charity there will be no inheritance tax to pay. However, many people only wish to leave a portion of their estate to charitable causes and the rest to family members and friends.
There are still advantages to charitable donations upon death, if you leave 10% or more of your estate to a charity, the amount due on the rest will decrease by some points. This is because instead of being calculated at 40% the rate reduces at 36%.
If you worry about the loved ones being chased by the fiscal authority, you can state in your will that any inheritance tax due should be paid by the estate rather than individuals who received your gifts.
5th Way, Get Married Or In a Civil Partnership Before You Die
When you are married or in a civil partnership, you can give anything you own to your civil partner or spouse. This means that your estate will not have to pay inheritance tax on what the gift is worth.
There are rules to bear in mind with this option though which can become more complex if your spouse or civil partner was born outside of the UK or permanently lives outside of the UK. If this is the case, you should seek professional advice.
6th Way, Set Up a Trust To Potentially Avoid Inheritance Tax On Property
One issue that many people look at is how to avoid inheritance tax on property. Whilst this is a complex subject a trust can be one way to achieve this.
A trust is a legal arrangement that enables you to give cash, property or investments to somebody else to look after for the benefit of a third party.
You can, for example, put savings in trust for your children, or a spouse. There are two important roles required within a trust fund.
- The first is a trustee: this is the person that owns and manages the assets in the trust.
- The second is a beneficiary: this is the person that the trust is set up for.
When you put items in a trust they no longer belong to you and this is where the inheritance tax benefit arises. Setting up a trust to avoid inheritance tax does have a range of implications both for you and for family members, so it is advisable to discuss these at length with your solicitor or financial advisor when considering the options available to you.
7th Way, Take Advantage of Business Owner Exemptions
If you are a business owner, you can transfer interest in your business to a friend, relative or business partner without being subject to inheritance tax.
This transfer can be made before or at the time of your death.
8th Way, Transfer Agricultural Land or Buildings
Under the terms of the Agricultural Relief, it is possible to transfer certain types of buildings and agricultural lands without being subject to inheritance tax. The agricultural property that qualifies for Agricultural Relief is soil or pasture that is used to cultivate crops or to rear animals intensively. It also includes:
- stud farms for breeding and rearing horses & grazing
- growing crops
- farm buildings, farm cottages and farmhouses
- trees that are planted and harvested every 10 years (it is called short-rotation coppice)
- the value of milk quota associated with the land
- land not currently being farmed under the Habitat Scheme
- land not currently being farmed under a crop rotation scheme
- some agricultural shares and securities
9th Way, Give Your Money To Family Members And Friends
You can give money or assets as gifts to family members and friends who are not classed as your partner or spouse. However, to be classed as a gift, it really does need to be a gift. This means you have to give it outright, which means that you no longer have any benefit from it.
The value of any gift that you give will still be included in your estate value for inheritance tax purposes, but only for seven years. After this time, it is excluded from the total value and therefore cannot be taxed. Also, you should bear in mind that you can only give away limited amounts per year, up to £3,000 annually.
Experts are calling for the annual gift exemption to be raised — because had it risen in line with inflation since 1981, it would now be worth £12,000.
Capital Gains Tax may also be payable on certain assets, which is why it is worth discussing gifts with your solicitor or financial advisor to be completely sure.
You do not have to pay inheritance tax at the time of making a gift, regardless of its amount. And if you live for more than seven years after the gift is made, it is exempt from the tax generally.
The OTS recommends reducing the seven-year rule to just five years. If you think there is a probability you will die within seven years and your assets are likely to exceed the tax-free limit, bear in mind that HMRC could try to claim some of your gifts back in tax.
10th Way, Give Wedding Gifts
Gifts in the form of property or money that you present to a relative at the time of their wedding are not subject to tax. If a child or another close relative is getting married, this is the perfect moment to pass on their inheritance to them so that they will not be subject to tax.
It could be a good idea to put a provision in your will, stating that they have already received their inheritance. So that they do not make a claim for further monies after you have passed away.
11th Way, Spend Your Inheritance
If you are faced with a terminal illness, this is a good time to treat your friends and family members to a special holiday or another type of experience that you can share together.
Not only will there be less capital after you pass away for your loved ones to be taxed on, but you will also have the chance to make some final memories that those close to you are likely to treasure for many years to come.
If you saved all your life, this is the right moment to use the money and have some fun.
12th Way, Buy a Funeral Plan
Many people are worried that, when they pass away, they will not have enough money for their funeral, burdening their loved ones with the cost with a funeral plan, you can arrange and pay for it in advance, so your relatives do not have to pay all the bills by themselves.
The cost of a funeral is rising and the average cost is between £3,000-£6,000. Therefore, you can deal with this cost upfront through the use of a prepaid funeral plan. These allow for you to pay for your funeral upfront meaning that money cannot then count towards your inheritance.
13th Way, Give Away Assets That Are Free From Capital Gains Tax
If you own assets, such as shares or property that have fallen in value since you bought them, they can be passed on without attracting any Capital Gains Tax (CGT).
A beneficiary generally is not liable to pay Capital Gains Tax on the inheritance they receive. However, if an asset is transferred to them from the Estate (such as shares or assets) and they then sell this later date for a profit, they could become liable for Capital Gains Tax.
14th Way, Are You Alone? Spend It All!
It is your money, you can do what you want with it! Why save your money knowing that a significant portion of it could be taken away through inheritance tax?
Why don’t you just enjoy life and treat yourself to some nice holidays and gadgets that are going to make your life easier?
15th Way, Make Use Of The Small Gift Exemption
You are allowed to make small gifts up to £250 per year to anyone you like. There is no limit to the number of recipients in one tax year, and these small gifts will also be free from inheritance tax, provided you have made no other gifts to that person during the tax year.
It is vital to keep a record of all the gifts you give and who receives them to avoid confusion in the future. Had the allowance risen along with inflation since 1980, it would now be worth £1,000.
If one of your children, now are adults and get married, you can give them up to £5,000 in gifts and £2,500 to your grandchildren.
As stated before, gifts can still be taxed of IHT if you die 7 years before you gifted them. If you last more than 7 years, they are naturally exempted from IHT.
16th Way, Passing On Your Pension
Your pension does not belong to your estate and assets, so when you die, it can be passed without inheritance tax. Therefore, if you die at the age of 75, your family can claim the entire pension tax-free within two years, says PensionBee.
In case you die after the age of 75, the relative that will claim it will also have to pay the IHT of 40% on it. If you have already started receiving your pension via drawdown and managed to die before 75, your beneficiaries can get a sum or drawdown payments without paying tax. If you die exactly at 75 or after, they will have to pay the IHT.
17th Way, Write a Will
You do not write a will just to pass assets, but in this case, it is also used as a tax planning vehicle, so for people maybe have been widowed in the past by structuring their will in the right way, they can actually capture potentially additional nil rates bands that may have been left to them by deceased spouses.
So not just in terms of controlling the assets, but also as a tax planning vehicle, the will is fundamentally important.
What happens in the case a person dies before writing a will?
Within the will, any gifts to the spouse or civil partnerships are exempt, whatever the gift is, any gifts to political parties are exempt, any gifts to the nation, so if you leave your land to the National Trust and gifts to charities.
Seek professional help
The OTS says that those who take financial advice usually pay fewer taxes than those who do not. Before asking for advice, you should consider if the IHT will ever catch you, in fact, fewer than 5% of estates are.
When it comes to avoiding inheritance you should speak to an estate planning specialist. They will be able to tell you what financial and legal approaches you can take to minimise any inheritance tax that may be paid from your estate.
For a DIY approach, there is no other way than writing the will and to review it regularly doing the research to make sure you are aware of any benefits or exemptions you may be eligible for.
This is obviously necessary if you live in a high-value or complex, in that case, it will happen and you have to mitigate the impact.
It is possible to reduce, or in some cases completely avoid, paying UK inheritance taxes.
However, what makes sense is to do some proper tax planning. Tax is one area of your professional life when you don’t want to pay the very lowest price for.
It is a complicated topic which is always changing. In fact, some of the rules could have changed if you are reading this article many months after it was published.
That makes getting advice even more important, and especially for those that are high net wealth, ultra high net wealth or expats.
As the UK’s response from the coronavirus has been more government spending and borrowing, it is highly likely that taxes will be raised in the future.
“The rich” might become an easy target for tax rises. Indeed they already have to an extent – as witnessed by the campaign against footballers and some other highly paid people.
That is one reason why people with assets should be prepared and diversified.
If you are a UK expat that is looking to repatriate, what are your options?
That is the topic of the article below.