Reviewed by James Badcock
There are several legal and effective ways to reduce inheritance tax – if action is taken early. From gifting assets during their lifetime to making a well-structured Will, planning ahead can make a big difference. Rules on inheritance tax can also change, so it’s always worth revisiting the situation regularly and taking expert advice to ensure any strategy is legally sound.
It’s important to be cautious, too. While there are many legitimate planning options available, there are those who promote aggressive tax avoidance schemes that are not legally effective. If something seems too good to be true, it probably is – so always seek advice from a reputable, qualified professional.
If you’re unsure what steps your parents have taken to manage inheritance tax, now might be the right time to speak with them. While the topic can feel uncomfortable, understanding their wishes and whether any tax-efficient plans are in place could spare you and your family a costly and stressful surprise later on.
If you’re new to the topic, and need a quick explainer, check out our guide to understanding inheritance tax. Otherwise, read on to discover what steps can be taken to reduce the tax burden.
Note: The information provided in this article is for general informational purposes only and should not be considered a substitute for professional advice.
1. Put a Will in place and use the spouse exemption
If your parents don’t have a Will, their estate will be divided according to the statutory intestacy rules. This could mean part of their taxable estate goes to children rather than the surviving spouse. This would trigger an inheritance tax bill, whereas if they had passed to the spouse they would not have been.
A properly structured Will can ensure assets pass tax-efficiently, often first to a spouse (which is exempt from inheritance tax) and later to children or other heirs. A Will is also important where you have more complicated situations, such as blended families, to ensure people inherit as your parents would wish.
It’s a good idea to get advice from a solicitor or professional will writer for advice on structuring more complex Wills like this.
2. Leave their home to you or another direct descendant in their Will
The main residence nil-rate band applies if your parent leaves their home to a direct descendant. This can significantly increase the tax-free threshold.
If your parent has a large house they can no longer manage, they may want to consider gifting it to you or someone else while they’re still alive, and going to live somewhere else.
They can also gift their house and continue to live in it — as long as they pay full market rent to the new owner and don’t benefit from the property in any other way. This should avoid a gift with reservation of benefit. If done correctly, it could remove the home from their estate for inheritance tax purposes. However, this arrangement must be carefully structured and fully documented, and the rent may be taxable income for the new owner.
But, keep in mind:
- The seven-year rule applies: they must survive seven years after gifting.
- Spouse exemptions and the additional nil-rate band won’t be available if they die within those seven years.
- There could be capital gains tax implications if the home is not their main residence. Stamp duty land tax (SDLT) may also apply if the person receiving the gift takes on a mortgage.
Planning with the family home can be complex, and it’s important to look at the full picture – not just the tax considerations. It’s strongly recommended to get professional advice before going ahead with any gifts or inheritance planning involving property. There may also be other options available that suit your family’s needs and circumstances better.
3. Make charitable donations
If 10% or more of an estate’s net value is left to charity, the remaining taxable estate benefits from a reduced inheritance tax rate of 36% (down from 40%). Not much of a reduction, but a reduction nonetheless.
If the entire value of the estate that’s above the nil rate band is donated to charity (provided that charity or charities are registered in the UK) then it’s not taxed at all.
Understandably, when that’s a substantial amount, you, or your parent, may not want that to happen.
4. Use their annual tax-free gift allowance
Anyone can give away up to £3,000 of their money or belongings each year free of inheritance tax. If they exceed this and then die within seven years, then the seven-year rule applies and those gifts may be counted as part of their estate and possibly liable for inheritance tax. It could also happen that the person who received the gift becomes liable to pay tax on it.
It’s worth checking what HMRC considers a gift, and understanding the inheritance tax rules that apply to lifetime gifting – it can be surprisingly complex.
For example:
- You may gift £250 to as many people as you want a year, but not if you’ve already used the £3,000 allowance on them.
- There are multiple occasions where you may give someone more even though you’ve used the allowance.
- Certain gifts made on specific occasions (like weddings) may qualify for exemptions.
If your parent has more net income (after tax) than they need to live on – for example, from pensions, investments, or rental property – they may be able to make regular gifts from the surplus income without it being subject to inheritance tax. This is known as the “normal expenditure out of income” exemption. To qualify, the gifts must be:
- Regular (such as monthly or yearly),
- Made from income, not savings, and
- Leave your parent with enough to cover their usual living expenses.
It’s important to keep good records of both the gifts and the income they’re made from, as HMRC may ask for evidence later. This exemption can allow for significant tax-efficient giving, but it must be handled carefully to meet all the conditions.
5. Set up a trust
A trust is a legal arrangement where trustees hold assets for the benefit of others. Trusts can be set up during someone’s lifetime or written into their Will to take effect on death.
Trusts are often used in situations where:
- Beneficiaries will be young, or may need protection from inheriting significant wealth too early
- The family situation is complex (for example there are children from a previous relationship)
- The estate includes business or agricultural assets.
However, the inheritance tax treatment of trusts is complicated, for instance:
- When someone transfers more than the inheritance tax threshold (currently £325,000) into most types of trust – such as a discretionary trust – during their lifetime, anything above the threshold may be subject to a 20% inheritance tax charge straight away. (This is known as a chargeable lifetime transfer, or CLT.)
- The seven-year rule also applies, meaning that if the person who set up the trust dies within seven years, the full 40% rate might apply.
- Trusts may also be subject to ongoing 10-year charges (up to 6%) and exit charges when assets are distributed.
There are exceptions – for example, bare trusts or certain trusts for disabled beneficiaries have different rules – which is why it’s essential to get expert legal or tax advice before going down this route.
6. Consider life insurance
If it’s not possible to avoid an inheritance tax charge through planning, your parents might consider taking out life insurance to cover the cost of the tax on their death.
To be effective, the policy should be written in trust, so that the payout doesn’t form part of their estate (which would otherwise increase the tax burden).
Life insurance tends to be more affordable and accessible earlier in life, as it can become expensive – or even unavailable – later on, especially if they’re in poor health.
There are several types of life insurance policies designed for different circumstances, so it’s a good idea to speak to a financial adviser who can help find the most suitable option.
7. Get professional advice
There’s no getting around it – inheritance tax is complicated. From setting up trusts to the complexity of the rules around gifting, things can quickly become confusing – especially if your parent’s estate is large or involves multiple assets.
That’s why it’s often well worth seeking professional advice. A reputable financial adviser or tax specialist can alleviate a lot of the worry, by helping you navigate the rules and put the right plans in place to save you a significant amount in tax.
While independent financial advisers typically charge around £150 per hour, and specialist tax advisers may charge more, a good adviser can save your family much more in tax than they’ll cost in fees
In summary
If you can persuade your parent to plan ahead for inheritance tax then that’s a good thing. There are some interesting options out there for reducing inheritance tax and because of the seven-year rule, the sooner they’re implemented the better.
On the other hand, your parent may not want to consider any of them and that’s a choice you will need to respect.
Common questions
- Can I reduce inheritance tax after my parent has died?
It is sometimes possible to vary the way in which your parent has left their assets, to reduce the inheritance tax payable. For example, if your parent did not make full use of the spouse exemption, leaving assets to their children instead, the children could vary the will to give the assets to the surviving spouse, who could later gift them to the children. This could reduce the overall amount of tax payable.
- What records should my parents keep for inheritance tax planning?
Good record-keeping is essential for effective inheritance tax planning. Your parents should keep clear documentation of any gifts they’ve made, including the date, amount or value, and who received them. This helps prove whether the seven-year rule applies. It’s also important to hold onto records of property ownership, valuations, any trusts created, and professional advice received. Keeping everything organised makes things far easier for executors and may help avoid delays or disputes after death.
