The conversations that could slash your inheritance tax bill

As many as one-in-five people over 55 have yet to discuss inheritance with their family, according to the findings of a survey from Mattioli Woods, an employee benefit and wealth advice firm.

It’s no secret that money is taboo for many people. From our salaries and how much we paid for our homes to the size of our pensions, lots of us feel it’s simply not “the done thing” to discuss the state of our personal finances – especially when we’ve done pretty well.

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But while there’s certainly no need to share this information with all and sundry, a failure to discuss money with close family could land them with a hefty tax bill when you die.

Without proper discussions about inheritance, families could miss the opportunity to distribute their wealth in the most tax-effective way or provide financial support when it’s most needed.

Compounding problems, the research also found that our knowledge of estate planning can be pretty patchy.

Although 83% of over-55s understand the importance of a properly drafted will and 63% know about the seven-year rule for lifetime gifts, only 15% are aware of nil rate band and residential allowances for inheritance tax (IHT). 

Furthermore, only a third (35%) realise that pensions will be subject to IHT from April next year – a move the government expects to bring an additional 10,500 into the scope of the tax in 2027-28 alone.

Understanding the basics

Currently, everyone can pass on £325,000 when they die (the nil rate band), with IHT payable at a rate of 40% on anything over this amount. But, if you have a family home that you’re passing to children or grandchildren, that allowance can be boosted by a further £175,000 (the residence nil rate band). Although we should note the residence nil rate band is reduced by £1 for every £2 your estate exceeds £2 million.

If you’re married, or in a civil partnership, you can also pass as much as you like to them tax-free when you die.

That means married couples with a family home that they’re leaving to direct descendants can potentially pass on £1 million before they need to worry about IHT.

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To shrink your taxable estate before you die, it’s possible to make lifetime gifts to loved ones. For these gifts to be tax-free you’ll normally need to survive seven years.

However, there are several allowances you can use to get money out of your estate immediately. These include a £3,000 annual gifting allowance and tax-free gifts worth up to £5,000 when those close to you get married. You can also regularly give away as much as you like from your income, as long as your executors can show that the gifts did not have an impact on your own standard of living, when the time comes.

How silence can hit your family in the pocket

Whether discussing money feels like a taboo, or you simply find it unsettling to talk about death – if your estate is likely to be taxable, there’s a benefit to discussing inheritances sooner rather than later.

Starting the seven-year clock: if you’re in the position to make large gifts in your lifetime – and you have a willingness to do so – delays could increase an eventual IHT bill. This is because you’ll need to survive seven years for the gift to become tax-free.

The problem, of course, is that unless you’re talking about money, parents may not realise that their children might get more benefit from it now, rather than in the future. At the same time, children may well feel uncomfortable asking parents for financial help.

Talking about the inheritance, as part of a wider conversation, makes it easier for everyone involved.

Making the most of annual gifting allowances: the £3,000 annual gifting allowance isn’t huge (it hasn’t increased since 1981). That means it won’t be terribly helpful if you’ve got a large estate and only start using it in your 80s or 90s.

However, if an IHT liability is identified earlier on and gifts equal to the annual allowance are pro-actively made throughout a retirement, they can be a much more effective tax-planning strategy. You can also carry forward the previous year’s annual exemption if unused.

For example, a couple, each using their gifting allowance for 20 years, could get as much as £126,000 out of their estate between them, saving the family £50,400 in tax.

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Solving one problem and creating another: many adult children will be incredibly grateful for an inheritance. It could pay off a mortgage or provide a vital top-up to their own retirement finances. But if your children are already wealthy and gearing up to navigate their own IHT planning, a large inheritance may only compound their challenge.

In these cases, a frank conversation will sometimes see some children encourage their parents to skip a generation and leave or gift money to grandchildren instead. Or the opposite can occur. Some parents might see their children living in a large and impressive house and not recognise the toll their mortgage or university fees have taken on their retirement pot, so instead leave money to grandchildren.

Missing opportunities to save: worried parents will frequently give money to cash-strapped children without wearing a “tax-planning hat”; they’re simply doing so to help. But unless, you’re also talking about IHT, you could miss an opportunity to cut a tax bill with gifts you’re already making.

If, for example, you’re giving your children regular help with costs for anything from school bills to mortgage repayments, music lessons or private tutors, it makes sense to take the necessary steps you’ll need to take advantage of gifts from surplus income rules.

This means ensuring you’ve got all the paperwork required by HMRC to show that they’re eligible, including letters explaining the gifts and records of income and expenditure.

Problems after you have died

There are numerous ways that conversations with family could help you manage an IHT bill better. But perhaps a more stressful consequence of a failure to talk is the prospect of disputes once you’re gone.

Increasing numbers of frustrated family members are challenging wills when loved ones die. And, according to a freedom of information request by TWM Solicitors, the number of people seeking to halt probate proceedings (with a “probate caveat”) has increased by 12% over the last year.

Complaints often occur in blended families, where a failure to plan can see children from previous relationships miss out when a parent dies. But there’s also a higher risk of a challenge when the contents of a will come as a surprise. By taking the time to have difficult conversations and explain your decisions, there’s less likely to be a problem when you die.

Start talking…and take advice

Talking about inheritance means raising two difficult subjects: money and death.

But if you’re worried about IHT or how best to distribute your wealth, it’s important to bite the bullet.

Mentioning that you’ve read an article about inheritance tax can be an easy segue. A birth, death, marriage or any other major lifestyle change can also provide a timely nudge.

Parents might want to raise the subject with children by saying that it’s important for their peace of mind to put plans in place. Similarly, adult children can start conversations by talking about arrangements they’ve made in their own wills or by sharing problems they’ve seen in their wider social circle.

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Think about timing as well. It’s sensible to give your family a bit of warning and avoid times when people are stressed or emotional.

It’s much easier to start being proactive once these honest conversations have taken place, but it’s important not to keep them in the family.

While different family members might be better informed about estate planning and IHT than others, that doesn’t mean they’re experts or have the required objectivity.

Talking to financial planners and solicitors can help ensure your wealth is distributed in a way that works for you and ensures you don’t pay any more tax than necessary.

But equally, their experience in later-life planning also means they’re well placed to be a neutral third party in family discussions.