Five ways to reduce Inheritance Tax – AJ Bell

by | Nov 25, 2022

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In the Autumn statement, the Chancellor froze the inheritance tax (IHT) nil-rate band at £325,000 until 2028, with the residence nil-rate ban also frozen at £175,000.

While the housing market may well fall in the next year or so, in the longer-term prices will recover and combined with likely increases in other asset values, this will mean more estates paying IHT. Indeed by 2026, the Treasury expects to be making around £500 million a year from freezing these allowances.

Laith Khalaf, head of investment analysis at AJ Bell, looks at some of the ways people can reduce the inheritance tax:

“Taxes don’t generally win popularity contests, but if there is one that gets people’s hackles up, inheritance tax is probably it. This is most likely because the time at which inheritance tax is levied is both upsetting and stressful, because beneficiaries will almost certainly be grieving, and having to deal with a lot of administration and paperwork too.


“Only around one in twenty five deaths result in an IHT liability, but at a rate of 40% it can really eat into the money you leave to your heirs if you fall foul of it. What’s more, that number is set to rise as the IHT nil-rate band has been frozen until 2028 and as asset prices rise, this will drag more estates into the IHT net. There are legitimate steps you can take to mitigate Inheritance Tax or avoid paying it all together, though some of them are complex and potentially costly.

“However you choose to deal with the question of Inheritance Tax, the most important thing is to make a plan in good time. It can be a difficult subject to bring up, particularly for those who stand to be beneficiaries, so if you’re in the fortunate position of having a large pool of assets to pass on, it’s probably a good idea to start the conversation yourself.”

1. Gifting


Gifting is probably the simplest way to pass your assets on to your children and grandchildren without paying Inheritance Tax (IHT). However, if you die within seven years of making a gift, Inheritance Tax will be payable on a sliding scale. There are some notable exemptions to this seven year rule however. In particular, everyone can gift up to £3,000 of their assets to beneficiaries each tax year without that sum becoming liable to Inheritance Tax, no matter when they die. A family wedding could be another occasion to consider passing some money on. Gifts of up to £5,000 to children made in advance of a wedding are protected from IHT, irrespective of when you die, and up to £2,500 for grandchildren. You are also allowed to make gifts from your surplus income, provided they are regular and documented. The rules around this form of gifting are complex, so it’s probably a good idea to seek the services of a qualified financial adviser if you are going down this route.

2. Consider pensions

A pension or SIPP (Self Invested Personal Pension) could also be a useful tool to pass wealth onto younger generations, though its purpose first and foremost is to provide you with a retirement income. You can nominate beneficiaries for your pension in the event of your death, which must be officially submitted to your pension provider, and IHT is not generally payable. If you die after the age of 75 though, your beneficiaries will need to pay income tax on money they take out of the pension, which could be 20%, 40% or 45%, depending on whether they are a basic, higher, or additional rate taxpayer. The amount of income tax paid can be mitigated by withdrawing money from the SIPP gradually. Or non-taxpayers, such as children, would pay no tax on withdrawals up to the annual tax-free income allowance, currently set at £12,570.


3. Set up a trust

Setting up a trust to hold your assets is another option to consider, though this is a complex area, which definitely requires a financial adviser to walk you through it. The benefit is that whoever you appoint as the trustee can control the assets, rather than them being passed onto the beneficiaries right away. This might be useful if you are concerned about gifting assets to a loved one who is perhaps not renowned for their financial prudence, or perhaps to young grandchildren. Trusts can be expensive to run and subject to tax charges, which together with their complexity generally makes them worthwhile in only a few circumstances.

4. Invest in AIM stocks


Investing in some AIM shares also comes with IHT benefits, because many stocks on London’s junior market qualify for Business Property Relief. Though you must hold the shares for a minimum of two years before you are eligible for this IHT exemption, and not all AIM shares qualify. HMRC has published the rules which determine which sort of businesses qualify for this relief, but they don’t publish a definitive list unfortunately. So there is some risk of misinterpreting the rules here. You also shouldn’t invest in a company simply for tax purposes. If you make a poor investment it can end up costing you an awful lot more than 40% Inheritance Tax. If you don’t wish to select shares yourself, there are some professionally managed AIM portfolios available on the market, though they do tend to be quite expensive in terms of charges.

5. Buy insurance

Another option to consider is setting up an insurance policy which pays out when you die and thereby covers any inheritance tax liability. The policy should be written in trust, so the payout doesn’t fall into your estate and therefore be subjected to IHT itself. Again, the guidance of a financial adviser should be sought here. This route offers you peace of mind that your beneficiaries won’t struggle with a huge Inheritance Tax bill when you die, but you are effectively paying at least part of that bill while you are alive through your monthly premiums, which can be substantial. If you die quite young, you probably get a good deal from the insurance policy, but if you live to a ripe old age, you won’t.


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