How much inheritance tax will I pay in 2023 – and how can I reduce or avoid it?

Inheritance tax is deeply unpopular and many see it as unfair - it’s part of the reason why The Telegraph has launched a campaign encouraging the Government to abolish it altogether. 

Grieving families paid a record £7.1bn in IHT bills in 2022-23, costing around £150m a week.

However, while the levy is still around, the best you can do is try to avoid it (legally) through effective planning. 

So how do you calculate what you have to pay, who exactly qualifies for these protections and how has the system changed? 

In this guide we will cover: 

• What is the inheritance tax threshold?
• How do I calculate my inheritance tax bill?
• How does the seven-year rule work?
• What if I downsize?
• Should I set up a trust?
• Using equity release to gift money
• Using your pension to avoid inheritance tax
• Investing to reduce IHT
• Leaving money to children and grandchildren
• Other unusual ways to avoid inheritance tax

Should you be looking for a legal loophole or two to avoid this infamous tax, you might want to look into giving money as a gift, passing your assets straight on to another beneficiary such as your children or even investing in long-term shares and assets – all of which are listed on the junior Alternative Investment Market in London. 

Done right, you could even give away a £4m estate and pay no inheritance tax.

If you are looking to gift some of your money, be aware that a total of £3,000 can be given away per tax year without it being added to the value of your estate. This is known as your annual exemption.

Any unused annual exemption can be carried forward to the next tax year – but only for one tax year. The tax year runs from 6 April to 5 April the following year.

If you’re unsure how much inheritance tax you’re to pay this year – or are looking for ways to make your bill smaller, try our calculator and read our tips and tricks below.

What is the inheritance tax threshold?

Each individual is taxed at a rate of 40pc on all their assets above a threshold £325,000. This threshold is known as the nil-rate band.

But from April 2017 an added protection known as the “family home allowance”, or “main residence nil-rate band”, began to be phased in. This is now worth £175,000, and applies when you leave your main property to a direct descendant, such as a child, step-child or grandchild.

How do I calculate my inheritance tax bill?

The spousal exemption means married couples and civil partners can effectively pool their allowances to pass on up to £1m to their heirs tax-free. 

Estates over £2m lose the relief at £1 for every £2 over the threshold. Your estate will have no “family home allowance” at all if it’s worth over £2.2m.

If you pass away within seven years of making gifts that exceed the usual allowances, there may be IHT to pay. The 40pc rate is tapered depending on how long ago the gift was made, and anything owing will either be taken from the estate or – if there’s not enough to cover it – the person who received the gift may be asked to pay up.

How does the seven-year rule work?

Seven really is the magic number when it comes to inheritance tax. Seven years is the length of time for any gifts to officially be counted as outside of your estate, meaning that when you pass away they will be outside the reach of inheritance tax. 

If you were to die within seven years, your heirs could face a tax bill – but, depending on how much time has passed since the gift was made, you won’t necessarily get a 40pc tax bill, as the tax rate tapers after the first couple of years.

Not all gifts come under the scope of IHT, and there are plenty of ways to avoid getting caught in the seven-year trap.

What if I downsize?

People who sell an expensive property will be eligible for an “inheritance tax credit” so can still qualify for the new threshold, as long as most of the estate is left to descendants.

This is known as the downsizing addition. It means you will be no worse off if you move to a lower value home or sell your house altogether to move into care. 

Should I set up a trust?

If you want to give money away to your heirs, but you’re nervous about what the recipient will do with it, you might consider setting up a trust. Not only can trusts help retain control about how and when the money is spent, but they can also reduce a potential inheritance tax bill – as long as you live at least seven years after setting it up.

It may also be worth putting life insurance into trust. Doing this means your loved ones don’t need to wait until probate is done for the policy to pay out, and the money won’t be counted as part of your estate when you die. Just make sure you follow the rules.

Using equity release to gift money

Equity release lets over-55s withdraw cash held in their property free of tax. For inheritance tax purposes, some people choose to gift this money to their loved ones as a way to take it out of their estate.

However, this is a complicated and somewhat risky strategy. Equity release is a form of debt that must be repaid either when you die or go into long-term care, and as borrowing costs are expensive it is only really suitable for those with large estates. Our guide can reveal the key rules you’ll need to remember if you’re considering this strategy.

Using your pension to avoid inheritance tax

Pension savings are considered to be outside of your estate for IHT purposes, making them a useful way to cut your tax bill. 

The important thing is knowing what kind of pension scheme you have, and how that can be passed onto your beneficiaries. Those with a defined contribution (DC) pension can leave a lump sum, while that won’t be possible if you have a defined benefit (DB) pension. That said, this kind of scheme will usually keep paying your spouse or nomination beneficiary after you’re gone.

Investing to reduce IHT

AIM shares qualify for business relief when the investor dies, once they have been held for more than two years. 

There are plenty of success stories that started out in the Alternative Investment Market, such as Fever-Tree and Young’s, but companies tend to be smaller and riskier, so you have a greater chance of losing your cash.

Leaving money to children and grandchildren

Parents wanting to send their children to private school could also benefit from the fact that transfers made for children’s education are exempt for inheritance tax purposes.

However, this exemption doesn’t extend to generous grandparents, unless they use the “surplus income” rule or survive the gift by seven years.

For grandparents wanting to pass on their wealth, there are several ways to do it while keeping it safe from the tax man, such as paying into your grandchild’s pension or Junior Isa, using trusts or using your own pension. There are different rules involved with each option, so make sure you’re clued up before you go ahead.

Other unusual ways to avoid inheritance tax

In addition to the unfair nature of inheritance tax, the levy is also incredibly complicated to navigate – not least because of the large number of carve-outs and reliefs that make it easier for the super-rich to avoid paying the tax, but more difficult for the middle classes to avoid it.

From inheriting National Trust buildings and rare works of art, to valuable war medals, there are lots of assets you can inherit that are outside the realms of IHT. We’ve found some other niche exemptions – you never know, they might help cut your bill.

This article is kept updated with the latest information.