How to Minimise Your Family’s IHT Liability

Insight | by Stephen Kiggins

Rising property prices and significant inflation have, in real terms, lowered the Inheritance Tax (IHT) threshold with each passing year, resulting in more and more people finding themselves liable for IHT

Rising property prices, stagnant thresholds, and evolving tax policies have turned inheritance tax (IHT) into a growing concern for many families. In the 2023/2024 Tax Year, HMRC receipts from IHT reached £7.5 billion, a 5.5% increase from the previous year. This growth is indicative of the increasing number of families whose assets are caught in the IHT tax trap, and highlights the importance of proactive financial planning to ensure that you are able to pass your wealth on to your loved ones in the most tax efficient way possible.

Annual Inheritance Tax (IHT) Receipts 2000 - 2024

Source Gov.uk national statistics: HMRC tax receipts for the UK

Changes announced in the 2024 UK Autumn Budget - including a shift to a 'residence-based' IHT system from April 2025, and how pensions are treated for the purposes of IHT from April 2027 - make it more urgent than ever understand the IHT new rules, and to plan ahead accordingly.

This article explains how IHT works, clarifies how these key changes to IHT could affect you, and outlines the ways in which you can minimise your family’s IHT liability.

Understanding UK Inheritance Tax (IHT)

Inheritance Tax (IHT) in the United Kingdom (UK) is a tax on estates of individuals who have passed away. It is applicable to the assets left behind, including property, savings, investments, and personal belongings.

IHT is charged at 40% on the value of an estate exceeding certain thresholds. Currently, the nil-rate band (NRB) is set at £325,000, and homeowners passing their property to direct descendants may benefit from an additional £175,000 residence nil-rate band (RNRB). However, estates worth over £2 million lose £1 of the RNRB for every £2 over the threshold.

For British expatriates, 'domicile' - not 'residence' - currently determines IHT liability, meaning that UK-domiciled individuals are subject to IHT on their worldwide assets, even after years of living abroad. From April 2025 however, IHT will transition to a residence based system.

Changes Coming into Effect

1. Change to 'Residence' Based IHT (Effective April 2025)

The move to a 'residence' based system shifts the focus away from 'domicile'. Under the new rules, individuals who have been non-UK tax residents for 10 consecutive years will benefit from having their non-UK situs assets excluded from liability to IHT. This change presents significant opportunities for British expatriates from a financial planning perspective to mitigate IHT exposure - and working with an international financial planner, ensure that their wealth is passed on to their family and loved ones in the most tax efficient way possible.

Worked Example

Robert, a British national, has lived in Dubai for 11 years. He owns property and investments in the UAE worth £5 million, in addition to UK assets valued at £500,000. Although he still considers the UK his permanent home, he has maintained non-UK tax resident status since his move.

Current IHT Rules: Under the current IHT regime, Robert’s entire estate, including his UAE assets, would be subject to UK inheritance tax if he were to pass away today.

Current Taxable Estate:

UK assets: £500,000
UAE assets: £5,000,000
Total = £5,500,000
Taxable amount = £5,500,000 - £325,000 = £5,175,000
IHT liability at 40% = £2,070,000 IHT payable under current rules

Post April 2025 IHT Rules: If Robert continues to maintain his non-UK tax resident status, his UAE assets would be excluded from IHT.

New Taxable Estate:

UK assets: £500,000
UAE assets: £0 (exempt after 10 years)
Taxable amount = £500,000 - £325,000 = £175,000
IHT liability at 40% = £70,000 IHT payable under proposed new rules

POTENTIAL IHT SAVING

£2,070,000 (current rules) - £70,000 (proposed new rules) = £2,000,000 saved in IHT

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2. Pension Assets Becoming Liable for IHT (Effective April 2027)

Currently, pension funds are excluded from IHT, allowing them to pass tax-free to beneficiaries. However, from April 2027, pensions will be included in estates for IHT calculations.

If the beneficiary is a higher or additional rate UK taxpayer, this could result in a combined tax rate of up to 67%, significant reducing the value of the inheritance.

Worked Example

A £500,000 pension fund inherited by an additional rate taxpayer could face:

1. An Initial IHT Charge of 40%
If IHT is due [because the value of the estate has exceeded the IHT nil rate band allowances] the pension funds would first be subject to the standard IHT rate of 40%, reducing the inheritance as follows:

Initial Pension Amount: £500,000
IHT at 40%: £500,000 x 40% = £200,000
Remaining Pension Funds After IHT: £500,000 - £200,000 = £300,000

2. Income Tax of up to 45% on Inherited Pension (if death occurs after age 75)
If the account holder's death is after the age of 75, the remaining inherited pension funds are subject to Income Tax at the beneficiary’s tax rate. If the beneficiary is an additional rate taxpayer, the income tax rate would be 45% [or 47% in Scotland]:

Amount Subject to Income Tax: £300,000
Income Tax at 45%: £300,000 x 45% = £135,000
Net Amount to Beneficiary: £300,000 - £135,000 = £165,000

POTENTIAL IMPACT OF NEW IHT RULE

From the original £500,000 pension, the beneficiary would ultimately receive only £165,000 after both IHT and Income Tax are applied, resulting in an effective total tax rate of 67%.

Minimise Your Family’s IHT Liability

1. As a British Expat, Establish and Maintain Your Non-UK Tax Residency

Under the new residency basis of IHT¹ an individual will not be treated as a ‘long-term resident’ for inheritance tax purposes in the tax year following 10 consecutive years of non-UK residence – meaning that their non-UK assets will then be outside the scope of IHT.
For high net worth and ultra-high net worth individuals, this pivotal change in IHT policy offers a compelling financial incentive to re-locate, set the ‘10 year clock’ in motion as soon as possible, and restructure your estate, to minimise or even negate your IHT exposure.

Now, more than ever, it’s imperative to seek expert advice
and put in place a long term plan to establish
and maintain your non-UK tax resident status,
in order to preserve your wealth for
your family and for future generations.

If you are currently a British expat, and have already established non-UK tax resident status, maintaining that status will become a strategic priority, as returning to the UK could once again bring your overseas assets within the scope of IHT.

To understand more about establishing and maintaining your non-UK tax resident status, and how we can help you put in place a long term financial plan to manage and protect your wealth, contact us today to schedule an initial consultation.

2. Considerations for UK situs assets

Trusts

The Government’s nil-rate band has remained frozen at £325,000 since the 2009/2010 tax year. As mentioned, the additional £175,000 residence nil-rate band can provide some additional relief to UK homeowners with children, but with property prices having risen dramatically, even those who bought their homes for a modest sum may now be subject to IHT.

Setting up a trust can be an effective way to mitigate IHT, as assets held in trust are typically outside of an individual’s estate. This means that the assets in the trust are not subject to IHT when the individual dies.

There are a number of trusts that can be used as part of your estate planning, but to identify the structure that would work best for you and for your beneficiaries, one of our qualified advisors can discuss your specific circumstances and aims as part of an initial consultation.

Gift Rules

The UK operates a seven-year gift rule, which states that if an individual gives away an asset more than seven years before they pass away, it will be exempt from IHT. This can be one of the most effective ways to mitigate IHT, as making gifts during your lifetime can reduce the value of your estate and potentially reduce your IHT liability. However, if an individual gives away an asset within seven years of their death, the value of the asset will be included in their estate for IHT purposes.

If the individual were to pass away within 7 years of giving a gift, inheritance tax would be paid on a reducing scale. Gifts given up to 3 years prior to death are taxed at 40%, and gifts given between 3 and 7 years prior to death are taxed on a sliding scale known as ‘taper relief’.

The following gifts can be given in the 7 years prior to death without any IHT needing to be paid:

Each year you can give up to £3,000 to anyone you like. You can also use the previous year’s exemption if you didn’t make use of it at the time. If, for example, your granddaughter was buying her first home, you and your spouse could potentially give her £12,000 for her deposit at once – assuming neither of you gave £3,000 away the previous year.
If you have extra income that you don’t require, you can make regular gifts to others. It’s important that you keep a record of these.
You can give your children up to £5,000 for their wedding and up to £2,500 to your grandchildren. Few people realise they can also give wedding gifts of up to £1,000 to others.
Any donations made to charities or political parties are inheritance tax free, whether you give them in your lifetime or your will. This includes property, shares and land.
You can reduce the rate of IHT for your whole estate to 36% by leaving at least 10% of your net estate to charity in your will.

Family Investment Company

Sometimes outright gifts to family members might not be appropriate. However, holding investments in a separate company – a ‘Family Investment Company’ (FIC) – might be a good alternative option.

An FIC enables you to benefit from lower tax rates on investment income and gains. The timing of tax liabilities on the distribution of funds to shareholders can also be managed.

To find out more about setting up a Family Investment Company and whether this could be the right option for you and your family, speak with one of our qualified advisors who will be glad to discuss this with you as part of an initial consultation.

Creating and Reviewing Your Will

Creating and regularly reviewing and updating your will can help to ensure that your assets are distributed in the most tax-efficient manner. You should consider writing a will that takes advantage of the nil-rate band and other reliefs and exemptions available to reduce your IHT liability. We can explain this in more detail and put you in touch with someone who can arrange this for you.

Preparation, planning and protecting your assets

It’s important to remember that UK tax laws and regulations are complex and can change over time, so it’s important that you seek professional advice from a qualified financial advisor to ensure that you continue to take the most efficient steps to protect your estate and mitigate your IHT liability.

To speak with one of our expert advisors about your financial and inheritance tax planning, and how we can help you pass on your wealth to your loved ones in the most tax efficient way possible, contact us today to arrange a consultation.

^1. HM Treasury Policy Paper – New residence-based regime for inheritance tax - 8 August 2024

This communication is for information purposes only and does not constitute financial, legal, or tax advice. To receive personal advice on financial planning, wealth management and pension solutions, please schedule a meeting with one of our Financial Advisors and Pension Specialists.