Will I Need to Pay Inheritance Tax?

Will I Need to Pay Inheritance Tax?

Navigating the complexities of inheritance tax can be a daunting task for wealthy families in the UK, particularly with fast-changing inheritance laws. With significant assets at stake, understanding tax allowances is important to preserving your wealth for future generations.

This article unpicks the intricacies of the UK’s inheritance tax system for UK domiciled individuals, exploring the thresholds, reliefs, and strategies that can help mitigate your tax liability.

Who pays Inheritance Tax?

Anyone who has been UK resident for 10 out of the previous 20 tax years will be liable to UK inheritance tax on their worldwide estate.  Once an individual has been UK resident for 10 out of 20 years they are known as a Long-term UK resident.  For anyone who is not a long-term UK resident, they will only be subject to IHT on their UK situs assets.  To understand about domicile and whether you are either UK domiciled or deemed-UK domiciled and thus subject to IHT, please see this article https://www.bentleyreid.com/domicile-and-uk-iht/

Labour’s proposed plans would mean that individuals who are UK resident for at least 10 years would become subject to UK inheritance tax, potentially for up to 10-years after they leave too.  All this is currently being consulted on, and for the purpose of this article we are outlining reliefs that currently apply to anyone subject to inheritance tax.

Understanding the Nil-Rate Band

The Inheritance Tax (IHT) nil-rate band, which is the threshold before IHT is due, has been frozen since 2010. With the increase in house prices since then, many more people now find themselves within the IHT net. Currently, the nil-rate band is £325,000 per person (£650,000 for a couple). Anything above this threshold is subject to a 40% tax rate upon death.

The Residential Nil-Rate Band (RNRB)

This additional relief was introduced for individuals passing on their main residence to direct descendants, instead of being a simple relief it is an unnecessarily complex calculation to work out what relief applies. As of the 2023/2024 tax year, the RNRB is set at £175,000 per person. Combined with the standard nil-rate band of £325,000, this means an individual can potentially pass on up to £500,000 free of IHT, or up to £1 million for a married couple or civil partners.

This allowance tapers off for estates valued over £2 million, reducing by £1 for every £2 above this threshold. The relief can also be available on a higher amount where you have downsized your home.  Having the availability to use the RNRB effectively can significantly help reduce your IHT liability and help preserve your family home for future generations.

Leveraging Gifts to Reduce IHT

One of the most effective ways to reduce IHT is through gifts. Gifts made by an individual to another are generally caught by the ‘potentially exempt transfer’ rules. If the donor survives for seven years after making the gift, it should not attract any IHT. Additionally, taper relief can reduce the IHT rate by 20% for each year the donor survives beyond three years.  This is shown in the table below:

Survive	IHT Rate
1-3 years	40%
3-4 years	32%
4-5 years	24%
5-6 years	16%
6-7 years	8%

There are also some additional allowances which include:

• £3,000 per year (up to £6,000 if unused allowance from the previous year)
• Gifts of up to £250 each
• Parents can gift up to £5,000 to a child for their wedding, this reduces to £2,500 for gifts from grandparents and £1,000 if gifted from anyone else
• Gifts out of income – explained further below

Use of Trusts

For those who are cautious about gifting outright, trusts can be a beneficial tool for those who are non-long-term resident or who have their nil-rate band available.  For long-term residents, gifts to most trusts are Chargeable Lifetime Transfers (CLTs), which means that they are subject to an immediate inheritance tax charge (at 20%) if the value exceeds the nil-rate band.  If the settlor does not survive seven years, then additional tax may apply at rates up to 20%.

Once assets are in trust and provided the settlor cannot benefit, they should be outside of the settlor’s estate.  Instead, the trust is subject to the ‘relevant property regime’ which broadly means a charge on the net asset value of the trust every 10-years and an exit charge (a portion of the 10-year charge) when capital is distributed from the trust.  This is charged at rates of up to 6%.

Utilising Life Insurance

Life insurance can be a cost-effective method to cover any potential IHT bill. It ensures that your beneficiaries have the means to pay the IHT without having to sell assets or deplete the estate. This can be particularly useful for covering gifts that might be subject to IHT if the donor passes away within the seven-year period. 

Gifts Out of Income

Gifts out of income is another valuable relief. However, what does gifts out of income mean exactly?

• You must have sufficient income – so if most of your investment return is capital, this won’t count
• You must be able to cover all of your expenses using just your income – so no digging into that capital to cover anything you personally need for a year.  This includes everything you spend money on, holidays, beauty treatments, you name it, you need to cover it from your income
• Any income left over after is considered ‘excess’ and this is what you are able to gift
• You must be making those gifts regularly – i.e. monthly, annually, just not as a one-off

Understanding and careful planning with this relief is essential.  Bentley Reid can assist in mapping out your cash flows to determine the level of gifting that may be available.

Business Property Relief (BPR)

Significant changes to BPR are expected from April 2026.  However, investments in BPR qualifying assets could still qualify for up to 50% relief from IHT. BPR was introduced to ensure that small and family-run businesses can be passed on without incurring significant inheritance tax, which can cripple such businesses.  It has expanded over time and also includes investment in AIM listed shares.   It offers up to 100% relief from inheritance tax.  However, investing in AIM-listed shares or a single trading business carries substantial risks.

An alternative to these options is buying underwriting at Lloyds of London. The insurance portfolio is selected based on an individual’s risk profile, and the assets used as collateral, known as ‘Funds at Lloyds’, can qualify for BPR if the two-year minimum ownership condition is satisfied.

And just in case you haven’t heard this enough- the simple approach is to: Spend, Spend, Spend

Need more advice? Reach out to our experts:

Anna Warren – Tax Director

anna.warren@bentleyreid.com

Mike Winstanley- Director, Wealth Management

mike.winstanley@bentleyreid.com