The best gift a kid could wish for (inheritance tax planning)

Let’s be honest. When your bucket list is glistening with items like “Caribbean cruise”, “sports car” and “holidays with grandchildren”, it’s understandable why “inheritance tax planning” may be gathering dust somewhere at the bottom.

But it does matter. And contrary to what you might think, inheritance tax planning could be the very thing that liberates you to enjoy all the above with less guilt and more gusto.

So, if you want to maximise the wealth you pass onto the next generation while making sure you’ll always have enough to live the good life, this article is for you.

First up, let’s take a closer look at what we’re dealing with.


Inheritance tax: the basics

Inheritance tax is a hot topic right now. If the Conservative party’s recent manifesto announcements are anything to go by, it could become something that more people need to understand. This is the current lay of the land.

Inheritance tax (IHT) is a 40% tax charged to a person’s estate after they die. Their estate (assets in the person’s name) includes their money, house and contents and cars. Pensions sit outside the estate and so are not subject to inheritance tax.

There’s no inheritance tax to pay if the estate’s value is below £325k or assets above this threshold are left to a or charity. This tax-free allowance increases by £175k to £500k if the house is worth more than £175k and is left to the person’s children or grandchildren. If the estate’s value exceeds £2m, the additional £175k tapers away.

If passing assets on death to a spouse, these allowances can be passed to the spouse, too, for them to use on their eventual death.

Inheritance tax is charged on the part of the estate above these thresholds. It must be paid within six months of death and assets in the deceased’s estate are only released to beneficiaries once this is done.

If the thought of 40% of your wealth going to the tax office instead of your loved ones is a bit hard to swallow, you’re in good company. Thankfully, there are ways to reduce the tax burden so that more of your wealth is preserved for future generations. And that’s where inheritance tax planning comes in.


Gift money early to reduce your inheritance tax bill

If you have children or grandchildren, it’s likely that they’re at a stage where some extra cash ­– for education fees, getting on the housing ladder or paying down a mortgage – could make a big difference to their prospects or quality of life. A great thing you can do to help your family is gifting some of your wealth to them early.

It’s a win-win. Because this money comes out of your estate seven years after the gift date (provided you are still alive), they get the full amount now, rather than 60% of the amount (after inheritance tax) later.

But here’s the million-dollar question: How much can you afford to gift? It’s good to be generous, but not if it leaves you worried about running out of money for yourself in the years ahead.

See what’s possible with financial forecasting

Financial forecasting has the answers. It means you don’t need to take a wild guess, close your eyes and hope for the best. You can take confidence in knowing exactly what you can afford.

In a nutshell, financial forecasting comes down to these five questions:

  • What’s coming in?
  • What’s going out?
  • What am I going to spend in the future?
  • What do I need as a buffer for emergencies?
  • What assets do I need to fund all this?

It sounds simple. But in reality, it’s hard to predict. That’s where financial forecasting models (like the ones we use as financial advisers) come in handy. They allow you to plug in the numbers and see how they respond in different hypothetical scenarios.

Here’s a simplified example.


This financial forecast shows that this person should have enough money to meet their expenses until age 110. This means it’s fairly safe to say that they can spare some money for a gift. But how much? Let’s see…


This financial forecast explores an alternative scenario – one in which this person gifts £100k to a child at age 70. If they make this gift, they’ll run out of money 10 years earlier, but this is still plenty to see them through to 100 years old. So, is it affordable? In all likelihood, yes!


6 ways to cure inheritance tax headaches

Inheritance tax can seem like a complicated topic. But that’s not the only reason some people don’t give inheritance tax planning the attention it deserves.

Many assume that their families will have enough from the inherited estate to pay the tax bill simply and quickly, and then keep what’s left. In reality, the process is rarely simple or quick!

The usual problem people have is illiquid assets. Houses are typically an estate’s largest asset, but its cash value is tied up until the property is sold. If a sale doesn’t go through before the six-month tax payment window, then the only way for people to cover the inheritance tax bill may be by taking out a large bank loan. This is a costly solution and an extra administrative burden.

So, how can you make sure your family don’t inherit a nightmare when the tax deadline comes around? With some savvy inheritance tax planning, of course!

Here are some steps you can take:

1. Get your pensions in order
As we’ve mentioned, pensions are a very tax-efficient way to pass on wealth because they sit outside of your taxable estate. Maximise the value of your pensions for as long as possible by drawing from savings before your pensions. And make sure your pensions go directly to the beneficiaries who are likely to be your executors so that they can use this money for the tax bill.

2. Spend down your ISAs
ISAs are only tax free while you’re alive. As part of your estate, they’re subject to the same 40% inheritance tax. If you have a spouse, you can pass on your ISA allowance to them on your death to retain the tax-free status. But if not, it pays to spend down your ISA along with your bank savings before drawing from your pension. This brings down the value of your estate so there’s less tax to pay and more left in the pension for your family.

3. Take out life assurance
A life assurance policy can pay the inheritance tax bill when the time comes. But be careful – if a life insurance sum pays back to you (your estate), it will add to the value of your estate and so bump up your tax bill, making the problem worse. This can be avoided by setting up the life assurance plan in the right way – something that specialist financial advisers can help with.

4. Move assets into trusts
Trusts are another way to reduce the inheritance tax bill. Putting an asset into trust will remove it from your estate – but only after seven years. There are caveats to the rules around trusts, so it’s worth exploring your options with a solicitor and taking action at the earliest opportunity.

5. Consider some high-risk investments
Don’t want to wait seven years for assets to leave your estate via gifts or trusts? You can fast forward the process by making certain in. These tend to be complicated so it’s prudent to seek expert advice and limit your exposure to these products.

6. Keep your Will up to date
Last but not least, it’s important that your Will is up to date and reflects your wishes. A good Will may not be able to change your inheritance tax bill by much, but it can at least make sure that your money ends up in the right hands at the right time, making the process smoother for your family and any other beneficiaries.

So, what does this look like in practice? This simplified example illustrates how a few inheritance tax planning steps can work wonders for reducing the eventual tax bill.


This scenario shows what might happen if a person doesn’t take any of the actions we’ve recommended above. As they draw down their pensions while not spending their savings, their taxable estate (light green) keeps growing. This leaves a large final IHT bill and a depleted pension pot that’s not enough to cover it. What should they have done differently?


This alternative scenario shows a much better outcome, made possible by actioning four of the simple steps we’ve recommended above. They’ve drawn down savings first to keep pensions intact, moved money out of their taxable estate through gifting, downsized their home to turn illiquid assets into cash which they can spend to further reduce the estate and preserve the pension pot. This leaves a small IHT bill that’s easily and quickly paid off from the pension’s surplus.


We’re here to help

As experienced Chartered Financial Planners, we’ve helped countless people like you get on top of inheritance tax planning and leave the best possible legacy to the next generation. We would love to give you the same peace of mind. Contact us for a free chat or learn more about how we can help.

The value of investments, and any income from them, can fall and you may get back less than you invested. 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.

Lets Chat

Talk to us

We’re here to help. If you have a question, comment or would like to arrange a chat, simply send us a message using this form and we’ll get back to you as soon as we can.