How to ensure more of your estate passes to your loved ones tax free

Historically, the lion’s share of an average estate would have been your main residence property value. But from 6 April 2027, your other significant personal asset, your unused pension fund, will also fall into your estate for the first time and be subject to IHT. Whatever funds are unused in your pension pot on your death will then be added to your other assets to calculate your family’s IHT liability.

WHY YOUR POSTCODE MATTERS

According to Savills estate agents, the number of property millionaires in the UK increased by 34 per cent over the past five years. There are now 702,580 UK homes valued at £1m or more.

In Scotland last year, the greatest number of properties worth in excess of £1 million were in Edinburgh’s EH3, EH4, EH9, and EH10 postcodes. Sales of £1m-plus homes have also been registered in East Lothian, Glasgow, Fife, and Aberdeen.

So, if you live in any of these postcode areas and add your property value to your unused pension fund, this calculation alone could take you beyond a £2m estate value. That’s even before you include your other investments and assets.

CURRENT ALLOWANCES

Everyone has a £325,000 IHT allowance. Any estate value above this is usually taxed at 40 per cent, except where passed to a spouse, civil partner or charity. This sum has been frozen for 16 years, and is scheduled to remain fixed until at least 2030.

RESIDENCE NIL-RATE BAND

Since 2017, there has been up to £175,000 additional allowance for anyone leaving their main home to direct family. So, currently, a couple can combine their nil-rate band of £325,000 as well as the residence nil-rate band of £175,000 to pass on assets of £1m IHT-free.

BEWARE OF THE £2m THRESHOLD TAX TRAP

Once the value of your estate passes £2m, the £175,000 residence allowance is tapered. For every £2 above the threshold, you lose £1 from the allowance. So, a couple with total assets of £2.7m would each lose the full £175,000 residence nil-rate band altogether. A £2.7m estate would then be subject to an IHT liability of £820,000.

FOUR STEPS TO HELP REDUCE IHT LIABILITY

The good news is that through careful financial planning and tax-efficient gifting you may reduce potential IHT liabilities and make sure that more of your estate passes tax-free to your loved ones.

We present four options to discuss with your financial planner, as the rules in this area are complex and advice should always be sought

GIVE GIFTS If you gift assets during your lifetime, they can reduce the value of your estate and potentially lower your IHT bill. You can give away £3,000 each year using your annual exemption, but you would obviously need to gift a much greater sum to make a real dent in your potential IHT bill. This is when the “seven-year rule” would apply. Many asset gifts, however substantial, will become IHT exempt if you survive for a further seven years. If you die before the end of the seven-year period, then tax will still have to be paid. But, if death occurs between years three and seven, then tapering relief on a sliding scale can be applied to reduce the liability from its maximum rate of 40 per cent.

SET UP A TRUST Trusts are a tried-and-tested tool we use regularly in IHT mitigation planning. Once you place an asset in a trust for a beneficiary it is no longer yours, although you can still place some restrictions on when it can be accessed and what it can be used for. Always take professional advice before making a trust.

REVIEW PENSION PLANS You could consider the benefits of purchasing an annuity with your pension pot where there may be options for reducing projected IHT. Again, financial planning is vital and this is a decision that shouldn’t be taken lightly.

LIFE ASSURANCE According to research, the average IHT bill paid by estates is now £243,000. Even older investors may be able to access life cover to fund that liability on their death.

For example, a 60-year-old non-smoker could expect to pay around £340 per month for a whole-of-life policy to fund that tax liability.

The Office for Budget Responsibility projects that IHT revenues will raise more than £14 billion for the UK economy in the 2029/30 tax year. That’s up from £9.1bn for the current tax year. It’s clearly time to start an IHT mitigation plan now to ensure that you and your family reduce the impact of such a huge increase.

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