How to avoid an inheritance tax shock

Michelle Holgate
Director, Wealth Manager
RBC Brewin Dolphin

Our Freedom of Information (FOI) request to HMRC found that more than 14,000 individuals were hit with unexpected inheritance tax (IHT) bills on lifetime gifts.¹

The findings revealed that 14,030 gifts became subject to IHT in the 2022/23 tax year after the donor died within seven years.

These families tried to use a gifting rule that allows individuals to make unlimited financial gifts free from IHT, provided the donor survives for a further seven years (known as the seven-year rule). Such gifts are known as ‘potentially exempt transfers’ (PETs).

Michelle Holgate, Divisional Director at RBC Brewin Dolphin, said: “Inheritance tax is paid by a few but feared by all. Many resent paying tax on already-taxed income, especially when grieving.

It makes sense to sit down with a financial planner early if you want to plan your gifting in what could be a potentially tax-efficient manner. Leave it until your 80s, and the risk becomes far greater that you won’t survive the full seven years.”

IHT on failed lifetime gifts

The top 25 ‘failed gifts’ had an average value of £7.9 million (after allowances and exemptions). This could trigger a surprise IHT bill of almost £3.2 million if the donor dies within three years of making a gift to family.

Considering all the 14,030 gifts, after allowances and exemptions, the average failed gift of £171,000 would incur a £68,400 tax bill if the PET failed within three years. The amount of tax owed on the gift, above the £325,000 threshold, depends on the time elapsed between the gift being made and the donor’s passing (called “taper relief”).

Years between gift and death	Rate of tax
0 to 3 years	40%
3 to 4 years	32%
4 to 5 years	24%
5 to 6 years	16%
6 to 7 years	8%
7 or more years	0%

The Office for Budget Responsibility projects IHT receipts will increase from £8.2 billion currently to £14.5 billion by 2029/30². This rise is partly due to increasing property prices, changes to IHT that were announced in October 2024, and the frozen IHT threshold, but also results from many families failing to plan early enough.

Planning ahead can help reduce the impact of surprise IHT bills triggered by the seven-year rule. However, the right approach depends on your circumstances and requires careful planning, so it’s important to seek financial and tax advice.

Taking control with trusts

For long-term family wealth planning, you could make use of trusts alongside lifetime tax-efficient gifts. Trusts allow indirect asset transfers managed by a trustee, making them an attractive option to manage potential IHT bills that could arise unexpectedly.

Holgate said: “Trusts can be used to ringfence funds in a way that is tax-efficient for inheritance. The type of trust is important to consider. Typically, there are two types of trusts used to pass funds down to the next generation. These are generally subject to the seven-year gifting rule.

A bare trust is a simple and effective way of allowing the donor to take advantage of various allowances in the child’s name.”

Another option is a discretionary trust, which offers flexibility in determining beneficiaries and payouts based on evolving needs, useful when planning for unborn grandchildren. “Crucially, grandchildren don’t have an absolute entitlement to the funds even when they reach the age of 18,” said Holgate. “However, these trusts can face upfront, periodic and exit inheritance tax charges.

With so much to consider, expert advice every step of the way makes sense.”

Covering tax bills with life insurance

Another option worth considering is a ‘gift inter vivos’ insurance policy to cover any tax due if the donor doesn’t outlive a large gift by seven years.

While a life insurance policy won’t diminish the IHT owed, it can prevent your beneficiaries from facing a substantial bill paid from your estate’s assets. Your beneficiaries may access the policy’s payout without awaiting probate, and it isn’t subject to IHT since the proceeds will lie outside your taxable estate if structured appropriately.

Holgate said: “These policies have a seven-year term and should be placed in a trust, otherwise the benefits from a claim on the policy may be added to the individual’s estate, thereby increasing the tax liability.” 

Exploring other gifting strategies

There are other ways to reduce your estate’s liability to IHT. For example, gifts of up to £3,000 each tax year; you can make small gifts of £250 per person, per tax year on the basis you have not used another allowance; and regular payments from income can be exempt from IHT.

Pensions are also useful for IHT planning as they usually fall outside your estate, so they can be passed to your loved ones free from IHT. The abolition of the pension lifetime allowance tax charge in 2024 allows you to build up a larger pension pot. This lets you pass on more wealth directly to your heirs when you pass away, without owing IHT first.

However, under planned changes, the value of the unused pension funds and death benefits will be included in a person’s estate for IHT purposes from 6 April 2027. This may have a significant impact on how pensions are viewed as part of succession planning and how you may wish to structure the income you take in retirement to ensure it’s taken as tax efficiently as possible.

Making your IHT plan

There is no one-size-fits-all solution. Your best strategy depends on your specific goals, assets, and family situation. An experienced wealth manager can explain all options like special insurance policies and gift trusts to make a real difference to your loved ones’ lives.

Without a plan, you risk IHT depleting your legacy. But estate planning can be complex – which is why it’s important to get some financial planning and tax advice. A wealth manager can help you build a robust, tailored estate plan that suits your needs and lays firm foundations for your family’s future.

Find out more from our dedicated support team calling us on 020 7246 1111. Opening hours are Monday to Friday 9am to 5pm.

Download our guide to inheritance tax.

¹ Freedom of Information request by RBC Brewin Dolphin to HMRC
² Office for Budget Responsibility May 2025

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The value of investments, and any income from them, can fall and you may get back less than you invested. RBC Brewin Dolphin is not a tax specialist and this does not constitute tax advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.

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