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Inheritance tax hacks

Posted By Finumus On In Savings | 38 Comments

“A voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.”
– Roy Jenkins

The previous article [1] I wrote on inheritance tax was my most commented on yet. Inheritance tax (IHT) must be really popular!

So let’s have some more…

Do you remember our fictional friends Sarah and Stephen [2] from that last post?

Just like them I’ve found myself quietly panicking about my family’s potential inheritance tax exposure, spurred on by the looming inclusion [1] of residual pension assets in the inheritance tax net.

I’ve long grasped the basics of inheritance tax planning:

But I’d never really sat down to think about how all these rules and exemptions might interact in… creative ways.

So today I’ll share a few thoughts, opportunities, and useful discoveries.

As ever, I’m writing about these inheritance tax hacks partly in the hope that even more interesting wrinkles will surface with your comments.

Don’t be shy if you know something we could all benefit from.

Keeping it in the family

This post is something of a sequel to the adventures of Sarah and Stephen in the mysterious realm of pension pots and inheritance tax.

Because today we turn our attention to Sarah’s parents: Mike and Mary.

After a few light edits to their circumstances – artistic licence, your Honour – this aging couple provide the perfect case study for some inheritance tax mischief.

For the sake of simplicity, we’re going to assume that Mike and Mary are in their 80s.

There’s a fair bit of uncertainty around whether either of them will live another seven years – the magic number for IHT gifts to fully escape the clutches of HMRC.

Mary is younger, and in better health. She is still able to complete a full Waitrose shop without a lie-down in the car park.

Mike… not so much. Let’s just say he’s the likelier candidate for an ‘estate-triggering event’.

We’ll also assume that, once pensions are dragged into the IHT net from 2027, their combined assets are comfortably north of £2.35 million. This means they won’t benefit from the residence nil-rate band, which starts tapering away at £2 million and disappears entirely at £2.35 million.

We’re also going to steer clear of business reliefs and agricultural land. I’m already going stir up enough vitriol as it is!

Get professional advice: Tax law is famously voluminous and everyone’s circumstances are different. These ideas are just to get you thinking. They may not work for you. Pay for the advice of specialists as and when you need it.

Potentially Exempt Transfers

You probably know the drill: if you give something away and go on to live for seven years, there’s no IHT to pay.

Hence ‘potentially’ exempt.

If you die sooner, the gift may still be exempt if it falls within your nil-rate band (£325,000). Or it may be subject to tapered IHT if you make it past the three-year mark.

Here’s the detail that gets interesting: There are no tax consequences for gifts between spouses. So in a married couple, who gives the gift actually matters.

Let’s say Mike and Mary want to give £1m to their daughter, Sarah. Most of that money is technically Mike’s. He could just write the cheque. But Mike is older, male, and has a bunch of ailments that mean he’s statistically less likely to make it seven years than Mary is.

So instead, Mike gives £325,000 to Sarah (within his nil-rate band), and the remaining £675,000 to Mary – his spouse. No IHT or CGT involved there. (Okay, technically, he can give Sarah £328,000 because there’s also a £3,000 per year ‘annual allowance’ as well. Whatever.)

Then Mary gives that £675,000 to Sarah as a PET.

This way we’re only betting on Mary living seven more years, which – barring errant buses – seems significantly more likely. The £675,000 is out of the estate if she makes it. The £325,000 was already within Mike’s allowance.

Voilà! Same gift, less tax risk.

The snag? A need to have some grown-up conversations about relative life expectancy. 

Capital gains tax

The PET rules are all well and good if you’re gifting cash. But if you’re handing over assets – like a second home or shares – then CGT rears its awkward head.

Let’s suppose Mary owns a London flat, worth £1.2m, which she inherited from her father in 1999 at a probate value of £200,000. She’s had it ever since, let out through an agent, and now hates everything about it [4] except the capital gain.

Mary would love to just give the thing to Sarah. But gifting the property is a ‘deemed disposal’ for CGT purposes. So she would be liable for CGT on the full gain:

Mary finds it absolutely ridiculous that she’d have to pay nearly quarter of a million of CGT to give a pokey little flat that was her dad’s to her daughter. But here we are.

She could sell it first, pay the CGT, then gift the proceeds. But that’s still £240,000 in tax.

Worse, if she gives it to Sarah and then dies shortly afterwards, Sarah is whacked with a 40% IHT charge on the whole property, too. That’s another £480,000. Total tax: £720,000 on a £1.2m asset – a 60% effective rate. Ouch!

Now here’s the thing. If Mary simply leaves the property in her estate, CGT is wiped at death. IHT will still apply, but CGT won’t.

That’s arguably better. But of course, you can’t sell a house to pay care home fees if you’re dead.

(There are occasionally rumours that the current government might change this to make both CGT and IHT payable on death – because they consider dying to be a naughty way of avoiding CGT).

The spousal CGT reset trick

Here’s a clever one I hadn’t clocked until recently.

Say Mike is likely to predecease Mary (because… well, let’s just say he’s not outliving anyone at this point).

Mary could gift the house to Mike – as a spousal gift, so no CGT arises. Mike then holds the asset, with the original £200,000 base cost.

Then Mike dies, leaving the house to Mary in his will. Again, no IHT because it’s spouse-to-spouse.

But here’s the trick: Mary’s CGT base now resets to the probate value on Mike’s death – let’s say £1.2m.

Mary can now sell the house immediately for £1.2m. No CGT, no IHT, full liquidity.

She can then PET the £1.2m cash to Sarah and, if she lives another seven years, the entire value is out of the estate. And all tax-free.

That’s £720,000 in potential tax saved, simply by playing a bit of last-minute spousal ping-pong with the property title.

Morbid? A little.

Effective? Very.

Regular gifts from surplus income

This is the closest we get to an IHT cheat code.

If you make regular gifts from your surplus income, and it doesn’t impact your standard of living, those gifts are completely exempt from IHT – immediately. No need to survive seven years.

There are three tests:

  1. The gifts must be part of your normal expenditure
  2. They must be made out of income (not capital)
  3. You must have enough income left to maintain your standard of living

Let’s take Mike. He has a £100,000 pension income – split roughly half from a DB scheme and half from SIPP drawdown. Post-tax, he nets about £70,000. His ISA is worth £1m and yields 2%, so that’s another £20,000 of untaxed income.

Total income: £90,000 post-tax.

Mike spends around £50,000 a year. So that’s £40,000 surplus. He could reasonably start a standing order to Sarah for, say, £2,500 per month – £30,000 per year – and claim that it’s regular expenditure out of surplus income.

Provided it’s well-documented, that’s fully exempt.

But what if Mike wants to ramp it up?

Well, Mike could reallocate his ISA into higher-yielding assets. For instance, the iShares GBP Ultrashort Bond UCITS ETF (ticker: ERNS) yields around 5%, which would give £50,000 of income on a £1m ISA.

Now he’s looking at £120,000 post-tax income, £50,000 expenses – so £70,000 surplus.

Maybe bump Sarah’s monthly gift up to £5,000?

Or if he gets adventurous – say, loading the ISA with infrastructure trusts [5] yielding 10% – that’s £100,000 income from the ISA. Add in the £70,000 pension income, and we’re now at £170,000 total income with £120,000 ‘surplus’.

£10,000 a month to Sarah? Quite possibly justifiable.

[6]

Or how about this?

[7]

What if Mike allocates all £1m in his ISA to the IncomeShares Coinbase (COIN) Options ETP [8]?

It’s quite likely that the vast majority of Mike’s million pounds will then be thrown off as income in the next 12 months (along with, in all likelihood, a 100% capital loss). He could be giving Sarah £100,000 a month of surplus ‘income’. 

I couldn’t possibly comment on either the merits of such an investment, or whether HMRC might take the line that this is a blatant attempt to artificially turn capital into income. You’ve been warned!

Again, seek professional advice. (And remember that tax planning mistakes [9] can be ruinous.)

Executors versus beneficiaries

A quick but vital point: executors are on the hook for sorting out the estate, filing the tax forms, and paying any IHT before distributing assets.

They’re personally liable for underpaid tax if HMRC comes knocking after the estate is distributed – and they can’t recover the shortfall from the beneficiaries.

If Mike names his cautious solicitor as executor, and said solicitor is asked to sign-off on the £1m ‘normal expenditure out of surplus income’ claim above… well, you can guess how that goes. The claim doesn’t get made, and the tax gets paid.

But what if Sarah is both executor and sole beneficiary? She ticks the box – believing in good faith that her dad thought call-over-write ETFs on super volatile stocks were an excellent investment – makes the claim, and takes her chances.

Worst case, HMRC disagrees later and she pays. But she’s kept control of the process and potentially saved six-figures in IHT.

If your executors are the same people who are inheriting, then they have the same incentives.

Before we leave ISAs behind

Another quick couple of reminders on ISAs:

  1. ISAs are inheritable by your spouse, and they can keep the tax wrapper intact. Technically they get a one-off ‘additional permitted subscription’ (APS) allowance equal to the value of your ISA when you die, allowing them to reconstitute it in their name. I hear that the APS process is far less bureaucratic if you and your spouse use the same platform for your ISAs. Worth aligning now to avoid form-filling grief later.
  2. The ISA wrapper doesn’t die when you do — not straight away, at least. It hangs around as a so-called continuing ISA [10] for up to three years or until the assets are distributed, whichever comes first. During that time, all income and capital gains remain tax-free. So if you inherit £1m of ISA investments, pulling the assets out immediately could expose you to income tax and CGT. But leave them in the wrapper and they can quietly grow, untaxed. The trick is this only really works if the estate stays in administration — something far easier to arrange if you’re both the executor and the sole beneficiary. (Another tick in the ‘advantages of being an only child’ column.) Say the portfolio returns 15% over that period, and your marginal tax rate is 40% — that’s £60,000 of tax you’ve sidestepped. Not bad for doing nothing, slowly.

Final thoughts

That’s probably enough for one post – and we haven’t even got into the complicated stuff like trusts. Let’s save that for another day.

If you’ve got other strategies, horror stories, or offbeat ideas, please do drop them in the comments.

Again – as always this is not personal advice. It’s not even pseudo-advice! I’m just a bloke on the internet [11].

For further reading, I highly recommend Your Last Gift: Getting Your Affairs in Order [12] by Matthew Hudson. It’s a surprisingly readable guide to getting your financial afterlife in shape.

Maybe give a copy to your parents? At a tactful moment.

Follow Finumus on Bluesky [13] (not that he ever posts there) or X [14]. Also read his other articles [15] for Monevator.