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How can I legally avoid Inheritance Tax?

Heart shape made from parents hands around baby feetTax laws are incredibly complex and without being an up-to-date tax specialist within the financial space, it’s unlikely you’ll ever be able to keep on top of every UK tax law that exists - or that indeed changes.

The government taxes society in many different ways, but one of the most difficult taxes to understand is arguably Inheritance Tax.

The standard rate of Inheritance Tax is 40%, but this is only charged on the part of a person’s estate that is valued above a threshold of £325,000 once they pass - or £625,000 if the estate is transferred to a spouse.

There is an additional property tax allowance of £175,000 per individual when a family home is passed on to direct descendants.

Do bear in mind that this tax percentage and threshold amount is always subject to change, so make sure you’re up to date with the latest figures and familiarise yourself with how inheritance tax works.

Between the years 2019-2020, it’s estimated that HMRC collected as much as £5.32 billion in Inheritance Taxes.

When our estate is taxed with this Inheritance Tax, it means that less money is left behind for our loved ones, or for the causes that mean the most to us if we don’t have our wishes in place before we pass.

Is there a way to avoid Inheritance Tax?

Fortunately, there are ways to minimise the amount of Inheritance Tax that is payable on your estate, and in some cases, avoid having to pay it altogether.

These include:

Combining inheritance tax allowances

Married couples and civil partners are able to combine their inheritance tax allowance, which allows them to pass on as much as £1m completely tax free.

Widows who receive their deceased spouse's £325,000 allowance can place it inside a discretionary trust together with their own £325,000 allowance (£650,000 in total), meaning should they choose to remarry, this £650,000 sum could be left to their new partner tax-free. Their new partner could add this to their own £325,000 tax-free allowance, resulting in a total tax-free sum of £975,000.

Writing a will - and keeping it up to date

A will ensures your assets are distributed according to your wishes and can also reduce the amount of Inheritance Tax that is liable to be paid on your estate. Without a will, assets are distributed in accordance with the intestacy rules, which could potentially leave them liable to lofty Inheritance Tax charges.

Read: What is the best method of writing a will?

Give your estate away

This may seem like it doesn’t make sense, and there are some caveats, but gifting your assets to those who you choose while you’re still alive will mean they avoid all liability to Inheritance Tax - provided you survive for at least 7 years after giving them away!

Even if you were to pass within the 7 years, the Inheritance Tax rate that is applied to the will be reduced.

In addition to this, people can gift £3,000 per year tax-free, and if no gift was made in the previous year the allowance increases to £6,000 for the same period of time. An additional £5,000 can also be gifted to help fund a child’s marriage and £250 can be gifted to someone for Christmas and birthdays.

Secure your assets in a trust

Placing your assets into a trust can help them avoid Inheritance Tax as they will no longer form part of your estate. Various trusts are available with a range of different benefits, and you can decide how they are released as your children or grandchildren reach a certain age. Some trusts, such as an “interest in possession trust”, allows you to receive an income from the assets while still avoiding Inheritance Tax once you pass, although the income received is liable to income tax.

Keep assets below the Inheritance Tax threshold

The most obvious thing to do would be to ensure the value of your estate remains below the Inheritance Tax threshold, but this can be understandably easier said than done, especially given the fact that the threshold can fluctuate as and when the government decides, and the value of your assets also have the potential to unpredictably appreciate in value at a faster pace than expected.

Make charitable donations

Donating to causes that matter to you can reduce the amount of Inheritance Tax that is paid on your estate. This is because donations to charity that amount to at least 10% of the overall value of your assets means a small deduction will be applied to the tax that is payable on the remainder, taking the Inheritance Tax from the standard 40% down to 36%.

Read: Leaving a donation to charity in your will

Regular or habitual gifts from surplus income

If your income exceeds your regular standard expenditure, you can gift the surplus income without having to pay any Inheritance Tax. The only rule is that the amount gifted cannot be increased as a result of a reduction in your standard of living. This type of gifting is known as a regular or habitual gift.

Take out a life insurance policy

Some life insurance policies cover any liability for Inheritance Tax. The insurance policy could also be placed inside a trust so that any pay-out is made outside of your estate.

If you’d like to gain a better understand about inheritance laws and contentious probate, don’t hesitate to reach out and speak to our expert team of solicitors here at Fonseca Law. You can contact us by calling 01495 303124, e-mailing or by completing our simple online contact form.