Inheritance Tax Planning: A Thorny but Manageable Issue

Inheritance tax (IHT) is often seen as one of the more complex and emotionally charged areas of financial planning. 

The matter of inheritance can be an awkward topic to discuss, both for children raising it with parents and for parents who may be reluctant to disclose details about their wealth.

Yet, one thing is almost universally agreed upon: no one wants to pay more tax than they need to. 

The good news? With careful planning, much can be done to reduce—or even eliminate—the burden of IHT.

What Is Inheritance Tax and Who Pays It?

Inheritance tax is a levy on the estate (property, money, and possessions) of someone who has died. 

In the UK, the standard inheritance tax rate is 40% on the value of the estate that exceeds the £325,000 threshold (known as the nil-rate band).

In addition, there’s a residence nil-rate band (RNRB) that can increase this threshold if the family home is passed to direct descendants (children or grandchildren). 

As of 2024/25, this allowance is £175,000, meaning a married couple could pass on up to £1 million without attracting IHT.

Inheritance tax is typically paid by the executor of the will or the person dealing with the estate. 

If the IHT is not paid within six months of the date of death, interest may be charged.

Why Inheritance Tax Is Often Called a ‘Voluntary Tax’

Accountants often describe IHT as a voluntary tax because, with enough foresight, numerous legitimate strategies can significantly mitigate its impact.

The key lies in early planning, where simplicity often beats complexity.

Here are two of the simplest yet most effective methods:

1. Gifts from Income

Regular gifts from surplus income are one of the most effective ways to reduce your taxable estate—and they fall outside inheritance tax rules entirely.

The key requirement is that these gifts must come from your income, not your capital, and they must be made on a consistent, regular basis (e.g., monthly or annually).

Crucially, these gifts must not impact your standard of living.

2. The Seven-Year Rule

Larger one-off gifts are also exempt from inheritance tax — but only if you survive seven years after making the gift.

If you die within this seven-year window, the value of the gift is added back into your estate for tax calculation purposes. However, taper relief applies after three years, gradually reducing the IHT liability (see Table below).

‍The Practical Case Study: Alice and Valda

At the heart of effective inheritance tax planning is a simple principle:prioritise the financial wellbeing of the person whose assets are being considered⸺whether that’s your parents or yourself.

Take for example Alice and her mum Valda, a widow in her 80s. Alice has been my client for many years, and has in the last few years starting discussing Valda’s future including her care needs and the future of her assets as she ages. 

At her last visit Alice asked me what the best approach might be to ensure that Valda still has everything she needs as she ages but Alice isn’t left with a tax burden when Valda eventually passes. 

To keep Valda’s affairs confidential, I suggest Valda comes to see me.

When I meet Valda, before we even start discussing possible strategies like gifts, trusts, or complex tax planning tools, we start with one fundamental question:

Valda, how much money do you need to live comfortably for the rest of your life?

Once Valda and I have established this we begin to determine how much of her nest egg is genuinely surplus.

Knowing this ensures that any gifting strategy for Alice is sustainable and doesn’t jeopardise the Valda’s financial security.

Once the surplus is identified, the next step is to determine the most effective way to reduce the Valda’s exposure to inheritance tax.

For clients like Valda, our focus is always on ensuring financial security first and foremost.

While reducing inheritance tax is important for Alice, it should never come at the expense of Valda’s financial wellbeing and peace of mind.

The Takeaway: Plan Early, Plan Simply

The best inheritance tax strategies are often the simplest: regular gifts from income, thoughtful one-off gifts with the seven-year rule in mind, and careful planning around what’s genuinely surplus to your needs can make a huge difference.

Engaging in these conversations early, even if they feel uncomfortable, is key. 

And while there’s no way to predict the future with certainty, by embracing a proactive approach to inheritance tax, you can take control and make informed decisions that protect your family’s wealth for generations to come.

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