Inheritance tax (IHT) receipts for 2021/22 in the UK were £6.1 billion. Overall, the UK government collected £915 billion in 2021/22 in public sector receipts, therefore inheritance tax made up less than 1% of overall government receipts. Despite this low percentage, it is a topic that gets a lot of play in the press and for many the idea of IHT or ‘death duties’ can be evocative. Working hard and paying tax your whole life only for additional tax to be due again on your death is difficult to stomach for many people.

The Bigger Picture

Its worth stepping back and putting inheritance tax in context. Annually, about 4% of deaths in the UK result in an inheritance tax liability. Granted, inheritance tax isn’t payable on assets that transfer between spouses, so this skews the figure slightly. But we can say comfortably that under 10% of estates in the UK, (after second death for a married couple) will pay inheritance tax. Clearly the tax affects a minority of the population, but it does seem to have an outsized significance in people’s thinking. A little education can go a long way to calm the nerves.

The Problem

There are nil rate bands (£325,000) and residence nil rate bands (£175,000) available to everyone, with some caveats, and married couples can effectively double up, adding up to £1 million that can be passed down IHT free on second death. However, with property prices so high, it’s easy for people who don’t consider themselves ‘well-off’ to be caught with an inheritance tax bill.

The Solution

For those with sizeable estates, there are plenty of simple strategies to reduce your inheritance tax liability.

It used to be standard practice to live off your pension in retirement, now, where possible it’s better to leave your pension intact and live off non-pension assets like ISAs or taxable share accounts.
If structured correctly, defined contribution pensions fall outside your estate and are not subject to inheritance tax. This strategy can reduce a potential inheritance tax bill, leaving the pension to grow free from inheritance tax.

Your beneficiary can then inherit the pension, and access the pension tax free or at their marginal rate of tax depending if you die before or after age 75. It is worth reviewing your pension contract to see if it allows for flexible death benefit options.

There are a host of gifting allowances; £3,000 per person per year and also allowances for wedding gifts. You can also make gifts out of excess income, provided there is an established pattern and the gifting doesn’t affect your normal lifestyle. This could be pension income or rental income that might just be accruing in your bank account, going unspent.

Larger gifts are subject to the potentially exempt transfer regime, which starts a seven-year clock until the value of the gift is no longer considered part of your estate. You should assess the affordability of larger gifts through cashflow modelling to ensure you don’t run out of money during your lifetime.

Property and the South East of England

About half of UK inheritance tax receipts are collected in London and the South East of England. This isn’t too much of a surprise; the geographic income disparity in the UK is well documented and the property prices in this part of the UK are a good bit higher. As property often drives up inheritance tax bills you can choose to downsize and spend or gift the surplus proceeds of a property sale. Equity release is a good option when downsizing isn’t palatable. Equity release can allow families to pass down wealth during their lifetime that is otherwise tied up in property or allow retirees a more comfortable retirement in their own home. There are drawbacks however, so this decision shouldn’t be taken lightly and you should seek professional advice.

There are a variety of other tax and investment planning options to reduce your inheritance tax liability. A life cover policy held in trust may be the easiest way to cover an IHT liability, but it can be expensive. If it is something you’re worried about it is worth having a conversation with an adviser, the issue might not be as big as you fear.