Seven inheritance tax planning mistakes to avoid

On paper, inheritance tax (IHT) planning looks pretty simple: give your money away and the taxman won’t be able to touch it. But it’s not as straightforward as it looks. The rules on how and when you give your wealth away are complicated; get them wrong and efforts to help your loved ones could quickly unravel.

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Here, we talk to estate planning specialists to share some of the most common IHT planning mistakes and get their tips on how to get it right.

1) Being too generous too soon

If you’re giving away sums that are in excess of the government’s gifting allowances, your gift will be a potentially exempt transfer, which means you need to live for a further seven years before it becomes wholly tax-free.

That timeline can rush people into making gifts before they’re ready. Tracy Crookes, chartered financial planner at Quilter Cheviot, says: “People sometimes hand over large sums of money without considering their own future needs, which can cause financial strain later in life. It’s important to strike a balance between helping loved ones and retaining enough wealth to cover care, medical, or lifestyle costs.”

She adds: “The average annual cost of a care home in the UK is around £50,000 to £80,000, and one in seven people may face lifetime care costs of more than £100,000.”

For some people, regular and affordable gifts from income could be a more tax-efficient and sustainable way to reduce the size of your estate. Madeleine Beresford, a partner in private client at TWM, explains: “These gifts out of surplus income are actually out of your estate instantly but you need to have a record and they need to be shown to be regular and have a pattern and most importantly not to be made at the detriment of your own lifestyle.”

2) Breaking ‘gift with reservation of benefit’ rules

If you give away an asset to get it out of your estate, you’ll be breaching HMRC rules if you continue to get any further benefit from it. The most obvious example is giving away your home, but continuing to live in it.

In 2023-24, HMRC investigated 220 estates which resulted in gifts worth £61 million becoming subject to IHT, according to TWM Solicitors.

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Beresford says: “The family home is notoriously difficult to tax plan with. People think that they can give their property to their children in their lifetime, and continue to live there, and if they live seven years it will be outside their estate. This is not the case, and will be caught by the ‘gift with reservation of benefit rules’ (GROB), which will bring assets back into the estate for inheritance tax, on death, irrespective of how much time has passed.”

The only way you can gift your home and continue to live in it, is to pay a full market rent to live there. “This rent would need to be paid for the entire period of occupation, not just the first seven years. People can fall foul of the GROB rules even decades after the gift,” she adds.

GROB rules would also apply if you gave a piece of art away, but continued to display it in your home, gave away a holiday home but still enjoyed weekend breaks, or gifted shares in a family business but maintained voting rights.

3) Misunderstanding taper relief

There’s a general misconception that taper relief on gifts will kick in after three years, reducing the charges that will apply to those gifts. “It is in fact the tax itself that tapers, and therefore gifts within the nil rate band will not taper at all. A gift of £325,000 (or £650,000 in the case of a transferable nil rate band), which is survived by six years and 11 months will still use the entire nil rate band, without taper.”

She adds: “If you’re hoping to rely on taper relief, gift in excess of the nil rate band to allow taper relief. Also make sure you’re aware of, and using all available lifetime allowances - annual exemption, small gifts exemption and normal gifts out of income.”

4) Overlooking your will

“Without a valid will, your estate will be distributed according to intestacy rules, which can be inefficient from a tax perspective and may not reflect your wishes,” warns Crookes. “Keeping your will current, especially after big life events such as marriage, divorce, or the birth of grandchildren, is essential.”

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In addition to ensuring your money goes to the right people, a will is a crucial part of the IHT planning process.

“For example, it can ensure that both the nil rate band and the residence nil rate band are fully used between spouses or civil partners,” she explains. “Leaving assets to a spouse or civil partner is completely free of IHT, so many wills are structured to take advantage of this before passing wealth to children or other beneficiaries.”

Leaving money to charities in your will can cut your tax bill too. “If you leave 10% or more of your net estate to charity, the IHT rate on the rest of your estate can fall from 40% to 36%.”

Beresford adds: “Wills can also include trusts, such as life interest or discretionary trusts, which provide flexibility, protect assets, and allow for future tax planning.”

Finally, if you own business or agricultural assets, you can use your will to direct these in ways that allow you to secure valuable reliefs and preserve wealth for younger generations.

5) Assuming trusts are tax-free

Paying money into a trust is another popular estate-planning tool, but it’s not a “get out of jail free card”.

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Beresford says: “So often people think that trusts, especially discretionary trusts, are a tax-free haven, and by assets passing to a trust via a will, they might either a) avoid tax on death and/or b) once assets are in the trust, they are never to be taxed again.”

Although discretionary trusts aren’t usually subject to tax on the individual’s death, they have their own tax regime, which means IHT may be payable on its 10th anniversary. 

She adds: “Take advice well in advance of the 10-year anniversary of the trust, to review whether the trust is still fulfilling its purpose.”

6) Putting tax savings above everything else

“There is a saying ‘Don’t let the tax tail wag the dog’ – which is to say, there may be circumstances where paying tax would be preferable to assets being diverted away from intended beneficiaries,” says Beresford.

For example, if you give money to children who get divorced or are declared bankrupt during your lifetime, it might not end up landing where you would have liked – it could be swallowed up in a financial settlement or used to pay back creditors. “It is sometimes a case of having 60% of something (i.e. net of tax), rather than 100% of nothing – it having been lost along the way,” she adds.

7) Not getting advice

While you might be able to manage your investments or pension yourself, DIY IHT planning is high risk. “IHT planning is one of the most complex areas of financial planning and mistakes are easily made,” says Crookes. “The best way to avoid costly errors is to get advice early, ensure your plans are regularly reviewed, and avoid relying on myths or half-understood rules picked up online or from friends.”