Eight ways to avoid inheritance tax

Often called Britain’s most hated charge, many taxpayers are keen to find ways to avoid inheritance tax.

Until recently it was only the very wealthy who had to pay it, but increasing numbers of families are now predicted to be caught up in the inheritance tax trap as the value of property has soared – pushing many estates over the threshold.

Data published by HM Revenue & Customs showed it received £7.5bn in inheritance tax in the financial year to the end of March 2024, £400m more than the same period last year. A further £6.3bn was collected between April and December 2024, meaning 2024-25 is on course to be a record year.

Official forecasts suggest receipts could top £9.5bn before the end of the decade – but, here, Telegraph Money reveals seven ways to cut a potential inheritance tax bill, or avoid it completely.

In this piece, we will cover:

• 1. Giving assets to your spouse
• 2. Leaving your home to your children
• 3. Giving away money
• 4. How the seven-year rule works
• 5. How a life insurance policy can help
• 6. Passing on your pension
• 7. Set up a trust to reduce inheritance tax liabilities
• 8. Business and Agricultural Relief
• FAQs

1. Giving assets to your spouse

If you want to cut your inheritance tax bill, then it helps to tie the knot. You can pass on assets of unlimited value to a spouse or civil partner without any inheritance tax liability. According to HMRC, on the first death couples shielded £15.7bn from inheritance tax in 2020-21, the latest year for which data is available.

Since the rules changed in 2007, spouses have also been able to inherit their partner’s unused nil-rate band when they die. This means the surviving spouse could see their allowance grow to £650,000. If the couple owned a home together, the allowance could be as much as £1m, as we explain below.

However, the unused allowance is not passed on automatically. You must make a formal claim to HMRC within two years of the death of the surviving spouse – otherwise your family could face an unnecessary tax bill.

2. Leaving your home to your children

For many families a property will be their most valuable asset. In fact, rising property prices are a major reason why annual inheritance tax revenue has doubled over the last ten years.

Fortunately, homeowners get an additional £175,000 allowance – called the “residence nil-rate band” if they pass their main property to family members. And because spouses and civil partners can combine their allowances, they can pass on a total of £1m wealth without incurring a tax bill.

But it pays to be aware of some age restrictions. Ian Dyall, of wealth manager Evelyn Partners, said: “The property must be a residence of the deceased and it must be left to children or grandchildren (not nephews, nieces, brothers or sisters).”

If the person downsized to a less valuable home before their death, they can still use the residence nil-rate band. This is called downsizing relief, and it can apply if you sold your more valuable home after 7 July 2015.

Calculating how much downsizing relief you can claim is complicated, however, as this depends on factors like the value of the residence nil rate band and also the home when it was sold.

Ms Griffin said although the residence nil rate band was introduced “to ease pressure on the transfer of the main residence”, the rapid growth of house prices means many who are entitled to it will nonetheless face hefty bills.

For estates worth more than £2m, the residence nil-rate band allowance is reduced at a rate of £1 for every £2 over the threshold. If the residence nil-rate band is not enough to protect your wealth, then you should make the most of gift allowances.

3. Giving away money

Perhaps the simplest way to avoid an inheritance tax bill is to give away your assets during your lifetime.

An often overlooked but highly tax-efficient method is to give money out of surplus income. This must be money you can give away regularly without significantly changing your lifestyle; it cannot be money that comes from a house sale, for example.

Chris Etherington, of tax firm RSM, said: “The gifts don’t need to be of equal size – they just need to be part of a pattern. You should also keep detailed records of the gifts made, in case HMRC asks for evidence of the gifts after death.”

On top of gifts out of surplus income, every individual gets a £3,000 annual exemption. Not many realise this can be carried forward for one tax year – so you could give away £6,000 if your allowance was unused in the previous year.

There are additional allowances for weddings or civil partnerships, although how much you can give varies depending on your relationship to the bride or groom, as shown in the table below.

Another exemption is the small gift allowance, allowing you to give away up to £250 each year per person – though not to anyone who has already benefited from your £3,000 annual exemption.

All of these gifts are immediately free from inheritance tax – that is to say, they are excluded from your estate. For gifts outside these categories, a seven-year rule applies.

4. How the seven-year rule works

Large gifts in excess of £3,000 can be made without incurring inheritance tax – but only if you survive the gift by seven years. This is widely known as the seven-year rule. During this window, the gifts are called “potentially exempt transfers” (PETs). If the value of the estate upon death, plus any PETs, exceed the tax-free allowances then inheritance tax is due.

Gifts made within three years of death are taxed at the full rate of 40 per cent – after that, taper relief will apply at the following rates.

For example, if you were to gift £400,000 and pass away four years later, the tax on the gift would be reduced from 40pc to 24pc due to taper relief.

Taper relief only applies if the total value of gifts made in the seven years before death exceeds the nil-rate band of £325,000, and a maximum of £1m when the deceased and their spouse have the maximum residential nil-rate band.

More and more taxpayers are falling foul of the seven-year rule.

Families were charged £221m on “potentially exempt transfers” in 2021-22, up from £135m in 2015-16, according to figures from HMRC. This is why it may make sense to give away more money at a younger age. However, Mr Dyall said: “It is obviously important to consider how much you can afford to gift in this way without leaving you or your spouse vulnerable.”

5. How a life insurance policy can help

If there is nothing you can do to avoid inheritance tax, you can still insure against the final bill. Taking out a life assurance policy means that when the tax is due, the charge can be paid out of your policy rather than by your beneficiaries.

However, it is important the policy is placed inside a trust to shield it from the estate. Otherwise, the payout will increase the estate’s value and potentially the amount of inheritance tax due as a result. Also, these plans can be very expensive. The older you are, the higher the premiums will be.

6. Passing on your pension

Pensions have been a great way to shield savings from inheritance tax, but this is set to change from 2027 when they’re brought into the scope of the levy. This means that unused retirement pots are likely to be included as part of your taxable estate and subject to inheritance tax.

For now, however, you can pass on the entire pot to your beneficiaries inheritance tax-free. So even if you had used up your nil-rate band and residence nil-rate band, you could still give away £200,000 in pension wealth, thereby saving £80,000 in inheritance tax.

Labour’s 2024 Budget announced that pension savings would come into the scope of inheritance tax, meaning this tactic will soon become redundant. Estates inherited before this won’t be affected, but it will pose problems for those who were hoping to use their pensions to shield money from tax for the longer term.

For those inheriting pensions, beneficiaries have to pay income tax as they draw down on the pension, but only if the original pension holder dies after the age of 75.

7. Set up a trust to reduce inheritance tax liability

Trusts are a powerful tool to help reduce the amount of inheritance tax your beneficiaries have to pay. Placing assets into a trust removes them from your estate, potentially avoiding any inheritance tax charges at the time of your death.

However, this depends on the structure of the trust along with a range of other factors, and you may have to make a tax charge when money is placed into the trust initially.

To fully understand how trusts work, you can read our comprehensive guide on how to set up a trust to protect your money and avoid inheritance tax.

8. Business and agricultural relief

If you own a business or agricultural land and property, you may be eligible for a significant amount of tax relief.

Business relief

As outlined by the Government, ownership of a business or part of a business is included in the estate for inheritance tax purposes. However, you can receive business belief of either 50pc or 100pc on some of the business’s assets. These can be passed on either as part of the will or at the owner’s discretion while still alive.

Agricultural relief

As announced in last year’s Budget, from 2026 agricultural relief will be limited to £1m, while assets above this threshold will receive 50pc relief. Two people who jointly own a farm will be able to pass on land and property valued up to £3m to a child or grandchild tax free.

These reforms are highly controversial, with farmers protesting against them several times in Westminster.

You can head to the government website to determine if you’re eligible.

Inheritance tax FAQs

Does writing a will help avoid inheritance tax?

Having a will in itself does not change how much inheritance tax your estate will pay, but it will enable you to decide how your assets are distributed. Without a will, your estate will be dispersed under the “intestacy rules” so it’s vital you have one, especially if you have children or complex finances.

Can you be exempt from inheritance tax?

Some assets can be exempt from inheritance tax, depending on who you leave them to. There is a spousal exemption, which means assets passed to a spouse or civil partner are exempt when one partner dies – even if they exceed the tax-free allowance. The same applies to assets passing to charity on death. If your entire estate were to pass to a charity, there would be no inheritance tax due.