How to avoid an inheritance tax shock

Inheritance and estate planning
Views & insights

UK families faced unexpected inheritance tax (IHT) bills of up to £1.4m in 2023. Here are some ways to avoid a tax shock.


18 April 2024 | 3 minute read

Our Freedom of Information (FOI) request to HMRC found that more than 13,000 of the UK’s wealthiest families were hit with unexpected inheritance tax bills of up to £1.4 million on lifetime gifts.

The findings revealed that 13,380 gifts became subject to inheritance tax (IHT) in the 2020-21 tax year after the donor died within seven years.

These families tried to use a gifting rule that allows individuals to make unlimited financial gifts free from IHT, provided the donor survives for a further seven years (known as the seven-year rule). Such gifts are known as ‘potentially exempt transfers’ (PETs).

Carla Morris, financial planner at RBC Brewin Dolphin, said: “Inheritance tax is paid by a few but feared by all. Many resent paying tax on already-taxed income, especially when grieving.

It makes sense to sit down with a financial planner early if you want to plan your gifting in what could be a potentially tax-efficient manner. Leave it until your 80s, and the risk becomes far greater that you won’t survive the full seven years.”

Inheritance tax on failed lifetime gifts

The findings show the top 50 ‘failed gifts’ averaged £3.6 million after allowances and exemptions. A gift of this size would trigger an eye-watering £1.44 million tax bill if the PET failed within the first three years.

Considering all the 13,380 gifts, after allowances and exemptions, the average failed gift of £156,000 would incur a £62,400 tax bill if the PET failed within three years. The amount of tax owed on the gift, above the £325,000 threshold, depends on the time elapsed between the gift being made and the donor’s passing (called “taper relief”).

Years between gift and deathRate of tax
0 to 3 years40%
3 to 4 years32%
4 to 5 years24%
5 to 6 years16%
6 to 7 years8%
7 or more years0%
Source: HMRC

It is estimated that IHT revenues will more than double from their current annual level of £7 billion to £15 billion by 2032-331. This rise is partly due to increasing property prices and the frozen IHT threshold, but also results from many families failing to plan early enough.

Planning ahead can reduce the impact of surprise IHT bills triggered by the seven-year rule. However, the right approach depends on your circumstances and requires careful planning, so it’s important to seek financial and tax advice.

Taking control with trusts

For long-term family wealth planning, you could make use of trusts alongside lifetime tax-efficient gifts. Trusts allow indirect asset transfers managed by a trustee, making them an attractive option to mitigate potential inheritance tax bills that could arise unexpectedly.

Morris said: “Trusts can be used to ringfence funds in a way that is tax-efficient for inheritance. The type of trust is important to consider. Typically, there are two types of trusts used to pass funds down to the next generation and avoid the threat posed by the seven-year gifting rule.

A bare trust is a simple and effective way of allowing the donor to take advantage of various allowances in the child’s name.”

Another option is a discretionary trust, which offers flexibility in determining beneficiaries and payouts based on evolving needs, useful when planning for unborn grandchildren. “Crucially, grandchildren don’t have an absolute entitlement to the funds even when they reach the age of 18,” said Morris. “However, these trusts can face upfront, periodic and exit inheritance tax charges.

With so much to consider, expert advice every step of the way makes sense.”

Covering tax bills with life insurance

Another option worth considering is a ‘gift inter vivos’ insurance policy to cover any tax due if the donor doesn’t outlive a large gift by seven years.

While a life insurance policy won’t diminish the IHT owed, it can prevent your beneficiaries from facing a substantial bill paid from your estate’s assets. Your beneficiaries may access the policy’s payout without awaiting probate, and it isn’t subject to IHT since the proceeds will lie outside your taxable estate if structured appropriately.

Morris said: “These policies have a seven-year term and should be placed in a trust, otherwise the benefits from a claim on the policy may be added to the individual’s estate, thereby increasing the tax liability.” 

Exploring other gifting strategies

There are other ways to reduce your estate’s liability to IHT. For example, gifts of up to £3,000 each tax year; you can make small gifts of £250 per person, per tax year on the basis you have not used another allowance; and regular payments from income can be exempt from IHT.

Pensions are also useful for IHT planning as they usually fall outside your estate, so they can be passed to your loved ones free from IHT. The abolition of the pension lifetime allowance tax charge in 2024 allows you to build up a larger pension pot. This lets you pass on more wealth directly to your heirs when you pass away, without owing inheritance tax first.

Making your inheritance tax plan

There is no one-size-fits-all solution. Your best strategy depends on your specific goals, assets, and family situation. An experienced adviser can explain all options like special insurance policies and gift trusts to make a real difference to your loved ones’ lives.

Without a plan, you risk IHT depleting your legacy. But estate planning can be complex –which is why it’s important to get some financial planning and tax advice. A financial adviser can help you build a robust, tailored estate plan that suits your needs and lays firm foundations for your family’s future.

Download our guide to inheritance tax.

[1] Institute for Fiscal Studies (IFS) September 2023

The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.

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