In her October 2024 Budget, chancellor Rachel Reeves announced some important future changes to Inheritance Tax (IHT).
Currently, any wealth remaining in your pensions when you pass away doesn’t count towards your estate for IHT purposes. However, the chancellor suggested that this exemption should end from April 2027 onwards.
This could mean that your family is more likely to pay IHT on your estate in the future. Fortunately, there are ways to mitigate a large tax bill, with careful planning and a solid understanding of the complex IHT rules.
Yet, certain misconceptions could lead you to make sub-optimal decisions about your estate plan.
Read on to learn three common IHT myths to watch out for.
1. All wealth that you gift is free from Inheritance Tax
Before considering how gifting wealth could reduce IHT, and the myths around this, it’s first important to understand how your estate’s tax liability is calculated.
When you pass away, the executor of your will calculates the total value of your taxable assets and then measures this figure against a threshold called the “nil-rate band”. In 2025/26, this is £325,000.
You might also benefit from up to £175,000 through the “residence nil-rate band” when passing your main home to a direct descendant such as a child or grandchild.
Any wealth that exceeds your nil-rate bands is usually subject to 40% IHT.
So, if you can reduce the size of your estate and lower the amount that exceeds the threshold, your family may pay less IHT. Giving wealth to your loved ones while you’re alive is one of the simplest ways to achieve this, but it’s a common misconception that all wealth you gift is free from IHT.
In reality, there are several different gifting rules to understand.
First, you can pass your entire estate to a spouse or civil partner without IHT. They also inherit your unused nil-rate bands, meaning you could pass on up to £1 million as a couple.
In 2025/26, you also have a “gifting annual exemption” of £3,000. Any wealth you gift up to this amount is automatically free from IHT.
Beyond this, there are some specific exemptions including the “small gifts rule” and the “gifts from surplus income” rule that may allow you to make payments that immediately fall outside your estate.
However, any gifts you make that exceed the £3,000 gifting exemption, or don’t qualify for other exemptions, aren’t automatically free from IHT. These gifts are known as “potentially exempt transfers” (PET) and, depending on the circumstances, there might be some IHT to pay.
If you survive for seven years after making a PET, it will normally fall outside your estate for tax purposes. This is referred to as the “seven-year rule”.
Yet, if you pass away within the seven-year window, IHT is calculated on a sliding scale called “taper relief”.
As such, it’s not as simple as simply gifting wealth to reduce IHT right away. We can help you understand the implications of passing wealth to loved ones while alive to ensure you’re being as tax-efficient as possible.
2. There is no Inheritance Tax to pay on assets in a trust
Trusts are a useful estate planning tool and they could help you mitigate tax but it’s a myth that there is never any IHT to pay on assets in a trust.
When you (the settlor) place assets in a trust, they no longer form part of your estate. Instead, they’re managed by another person (the trustee) on behalf of a third person (the beneficiary).
Any wealth that you place in a trust is subject to the seven-year rule discussed previously. This means that if you pass away within seven years, some IHT may be due.
Also, the value of assets in a trust are normally assessed every 10 years. After the valuation, an IHT charge of 6% may be due on any wealth that exceeds your available nil-rate bands.
Even if you survive for more than seven years, your family could still pay IHT on assets in a trust when you pass away. However, IHT is normally due at a reduced rate of 20% on wealth that exceeds the nil-rate bands, rather than 40%.
Additionally, when your beneficiaries access wealth in a trust, they might pay some Income Tax, depending on their personal circumstances and the type of trust used.
All this means that trusts aren’t a straightforward way to mitigate IHT altogether, though they can be useful for estate planning. That’s why it’s vital to understand precisely which type of trust is most suitable for your situation and what the tax implications could be. Professional support can help here.
3. You can easily reduce Inheritance Tax by passing your home to your children while you’re alive
Your home is likely your biggest asset and may make up a significant portion of your estate. As house prices rise, the value of your property could easily exceed the nil-rate bands, triggering an IHT charge.
Where other assets are concerned, the gifting rules described above can be very useful. Passing wealth to your loved ones could significantly reduce the size of your estate for IHT purposes. However, you can’t necessarily do the same with your home.
If you passed the home to a direct descendant and lived for seven years, you might assume that it would then fall outside your estate for tax purposes. This might be true, if you no longer lived in the property.
Conversely, if you continue living in the home, it isn’t considered a PET. Instead, it is normally a “gift with reservation of benefit”. As you still live in the property, you benefit from it and so it still forms part of your estate for IHT purposes, even if it’s in somebody else’s name.
In some cases, if you pay rent in line with market rates, the property could be considered a PET.
It’s important to consider this specific rule if you want to pass your home to your beneficiaries while you’re alive.
Get in touch
Working with a financial planner could benefit your estate plan because we can help you understand the various IHT rules and avoid any costly misconceptions.
Please give us a call on 01276 855717 or email info@braywealth.com today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
The Financial Conduct Authority does not regulate estate planning or tax planning.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.
Approved by the Openwork Partnership on 08/04/2024
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