Most of us know, or at least have a good idea about what we’d like to leave to our loved ones after we’ve gone. But what’s less clear is how to go about making sure that happens. And our recent Class of 2022 research confirms this, with only 23% of this year’s retirees feeling confident about preparing their finances for when they pass away.

While having an up-to-date will is crucial, it’s also very important to make sure you’re not leaving behind a hefty inheritance tax bill for your loved ones to handle. Here are five things you can do to help reduce that potential bill.

1. Understand the basics of inheritance tax

Inheritance tax can apply when you pass on assets either during your life or on when you die. The amount that has to be paid depends on the value of your estate – that’s everything you own, including your home, savings, investments, and any possessions. Importantly though, it doesn’t include most pensions.

When you pass away, you can generally leave an estate of up to £325,000 without paying inheritance tax. That £325,000 is called the nil rate band.

Inheritance tax is charged at a rate of 40% on the value of your estate over the nil rate band, unless an exemption applies. The most common exemption is when an estate passes to a spouse or civil partner, in which case no inheritance tax is payable regardless of the value of the estate.

2. Realise the power in gifting

Giving gifts while you’re still alive is one way to reduce the value of your estate and therefore reduce your potential inheritance tax bill. Some gifts are exempt, which means the value of them leaves your estate immediately. There are two notable gifts that will be exempt:

• 1. The first is the ‘annual exempt amount’ - this allows you to gift up to £3,000 each year split between as many recipients as you like. And if you didn’t use this in the previous tax year, you can bring it forward one year and give yourself up to £6,000 to give away.
• 2. The second is the ‘small gift exemption’ - this allows you to make as many gifts of up to £250 as you choose in a year, as long as each one goes to a different person.

You can also give away any extra income you have that you don’t need to fund your current lifestyle as regular gifts, and the value of those will leave your estate immediately.

But any gifts that don’t fall within one of those exemptions will only leave your estate completely if you live for at least seven years after giving them.

It's important to highlight that gifts don’t only have to be made to other people. They can also be made to charities, in which case they’re exempt from inheritance tax and the value leaves your estate immediately. Gifts can also be made into a trust.

3. Think about trusts

If you have concerns about making a gift directly to another person, you could look at making it into a trust instead. Perhaps it would be a lot for them to manage, or you’re worried what could happen if they got divorced or had financial difficulties.

Trusts can be complex and are an area where specialist advice is really important. But on a basic level, it’s about working out:

• What you want to gift
This could be money, investments or a property for example.

• Who you’d like to have control over and make decisions about the gift after you’ve made it
This will be your trustees, and can also be you.

• Who you’d like to be able to benefit from that gift going forward
This will be your beneficiaries and can’t include you if you’re making the gift for inheritance tax purposes.

• How you’d like the beneficiaries to benefit going forward
These details will be specified in your trust deed.

Most gifts into a trust will take seven years to leave your estate completely. And if they’re over your nil rate band, there may also be inheritance tax to pay when the gift is made. Depending on what you put into the trust, you may also need to consider capital gains tax and other taxes too – so specialist advice is critical here.

4. Get to know who pays, how and when

If you have a will, the responsibility for working out how much inheritance tax is payable falls to your executors. The tax is then generally paid from the estate before it’s passed on to your beneficiaries. However, if the tax is payable because of a gift you made while you were alive, the person who received that gift will generally have to pay that inheritance tax.

If you don’t have a will, it will be payable by the person appointed to administer your estate, again from the estate itself.

If you die with money in your bank account, a portion or the entire tax can be paid directly from that account. Otherwise, the tax can be paid by selling investments or property for example.

Another thing to be aware of is that in most cases, the inheritance tax bill has to be paid within six months of the date of death. After that interest will be charged.

5. Plan ahead

With a bit of careful thought and forward planning, there’s a lot you can do to make sure that you leave as much as you can to the people you choose rather than to HM Revenue and Customs.

The best way to navigate passing on your assets and manage a potential inheritance tax bill will entirely depend on your individual circumstances. And if you need support, help is out there.

There’s a lot of free guidance available online. But given the sensitivity and possible complexity of passing on personal wealth, you may want to consider additional advice. Estate planning specialists can help you understand the value and make-up of your estate, prepare your will, and create an inheritance tax plan to lessen the bill for your loved ones.

Because it’s such an important and complex area, we’ve brought together financial, investment, legal, accountancy and tax expertise under one roof. So we can look after more of your needs in-house.

If you don’t already have an adviser, find out how we can help you manage and pass on your wealth tax efficiently.

The information in this article should not be regarded as financial advice. Information is based on abrdn’s understanding in August 2022. Tax rules can always change in the future. Your own circumstances and where you live in the UK could have an impact on tax treatment.