What investments are exempt from inheritance tax?

Inheritance tax (IHT) is part of a broader taxation system. It is a tax levied on a deceased’s estate with the politically controversial intention of limiting inherited wealth and redistributing income via the state’s coffers to the benefit of all.

One of the most disliked taxes, inheritance tax (IHT), may cost hundreds of thousands when a loved one dies. How much one pays is dependent on the value of the cash, belongings and property at the time of death. There are several legal ways to avoid it, as described below. 

Inheritance Tax thresholds

Currently, any estate valued above £325,000 is subject to 40% IHT. However, anything above this threshold left to a surviving spouse, civil partner, charity or an amateur sports club will not be subject to IHT. 

The deceased individual may leave the main property to a spouse or children. In this case, a further £175,000 is deductible from the value of the estate. 

The individual’s threshold increases to £500,000.

Here are some investment suggestions to avoid or reduce an individual's IHT exposure:

  • Pension funds

In 2014 HMRC made changes in how IHT applies to some pensions. The age of death and the type of pension determine their tax status.

Aside from a state pension, there are two types of pensions:

  1. A ‘defined benefit’ pension

The value of this pension is determinable by the final salary received and is payable over the remaining lifetime of the individual. The benefit of this income belongs only to this individual and, sometimes, his/her spouse if he/she survives him/her. A person cannot leave this income to anyone in the event of  death.

  1. A ‘defined contribution’ pension

A pension fund is contributed to by an individual during his working life. At retirement, the contributor may draw down 25% of the fund and invest the balance in an annuity to pay a monthly income until death. These payments are subject to income tax. Similar to a ‘defined benefit’ pension, in the event of death the annuity lapses.  

However, since 2014, instead of buying an annuity, the remaining lump sum can be left intact and accessed for draw-down lump sums by the individual. Anything remaining in the fund at the time of death can become part of the deceased’s estate. 

This undrawn portion of a pension fund is not exempt from IHT. It may be subject to income tax when drawn down by the beneficiaries. 

If individuals die before 75 years of age, the beneficiary will not have to pay tax on the remaining sum. If they die after their 75th birthday, the beneficiary will pay income tax based on their tax band.

  • Business Property Relief (BPR)

In the 1976 Finance Act, Business Property Relief (BPR) aims to protect family-owned businesses after a death. A company can carry on trading without the need for shares or the business to be sold to pay the inheritance tax liability. 

BPR is a popular way to minimise tax exposure following a death or on lifetime gifts.

In 2013, a decision allowed investors to hold BPR-qualifying, Alternative Investment Market (AIM) listed shares in an ISA. These shares are even more tax-efficient and advantageous to beneficiaries. 

  • Individual Savings Accounts (ISAs)

Tax-free Inheritance ISAs are an ideal way to avoid IHT. 

As mentioned above, these ISAs use Business Property Relief to exempt them from IHT. Investments in relatively small illiquid companies may be risky; however, the risk is worth avoiding the 40% IHT. Some ISA schemes offer an element of protection against the downside risk. 

  • An In-trust life insurance policy.

Suppose a person is aware that his beneficiaries will be liable to pay inheritance tax when he dies; in that case, he can invest in a whole life insurance policy to cover the total value of the IHT.

Whole life Insurance policies are structured to pay out at death, unlike term insurance which pays out within a specified period.

Writing the insurance policy in trust ensures the payout goes directly to the beneficiaries and will not be included in the deceased’s estate and, therefore, not subject to IHT.

  • Put your assets in a trust and still receive the income.

Trusts are very effective in keeping IHT as low as possible. The value of assets held in trust is exempt from IHT calculations. This is because the assets, cash, investments or property belong to the Trust.

Trusts are complex and professional advice is advisable. 

  • A discretionary Will-Trust

An individual with an estate valued over the IHT threshold could, in advance of his demise, set up a discretionary trust and gift the £325,000 threshold into this trust to benefit a group of beneficiaries. 

As long as the trust is established seven years before death, discretionary trust funds are not included in the estate.

The below suggestions are not necessarily investments in the true sense of the word but are alternative ways to reduce IHT

  • Make a Will

Making a will is an essential step in estate planning. Having one’s estate distributed according to one’s wishes, as opposed to through intestacy rules, avoids IHT.

There is no inheritance tax on assets inherited between spouses.

Several online companies offer will-writing services at affordable prices. These services are ideal for individuals whose affairs are straightforward. Individuals with multiple assets and investments may require specialist guidance; also quite accessible through online enquiries.

  • Gift your assets away.

Gifts between spouses or common-law partners are exempt from IHT. HMRC also allows an individual to gift £3000 annually to another individual. It is an ‘annual exemption.’

This amount can, if not used in a year, be carried over to the following year. This carry-over only applies once. 

Small gifts of up to £250 per year may be given unlimited to individuals in a year.

Wedding gifts may be given to avoid IHT. £5000 to an individual’s child, £2500 to a grandchild and a spouse, or £1000 to anyone else.

Gifts between spouses are exempt from IHT. No IHT applies to gifts to organisations such as charities, national museums, universities and the National Trust.

A gift is free of IHT if given seven years before a person’s death. Should the person die within seven years, ‘taper relief’ applies, and the person receiving the gift will be liable to pay IHT. This only applies if the value of the gift exceeds £325,000.

  • Equity Release Scheme

An equity release scheme takes some of the value of a home and releases it back as cash. 

A lifetime mortgage or a home reversion scheme facilitates this. 

Releasing equity from a property reduces the value of the estate resulting in a reduction in IHT payable at death.

It is possible to gift the released equity. However, should the person die within three years, the gift will be subject to IHT (40%). Taper relief is applicable from three to seven years before death. The tax liability reduces as more time passes between the date of gifting and the date of death.

  • A deed of variation

A deed of variation is a simple, tax-efficient way to avoid IHT. It needs to be applied for within two years of the death of the benefactor.

As an example, an individual inherits a large sum of money from an elderly relative. The inheritance is attracting a 40% inheritance tax. A deed of variation could avoid this taxation. 

A deed of variation re-writes the will of the deceased relative, directing the inheritance elsewhere. For example, the sum of money could be redirected to the next generation, grandchildren, or into a trust. The original recipient of the inheritance may still benefit from the trust.

There is a distinction between a ‘gift with reservation’ and a deed of variation. For example, the former occurs when the child of a deceased person inherits property, and they gift half of it to a grandchild. If the child still resides in the house, IHT is still payable. 

However, when applying for a deed of variation, it is deemed to have been made by the original donor who no longer has access to it.

  • A Charitable Legacy

Anything left to a charity does not incur IHT. Additionally, the sum left to a charity (a Charitable Legacy) is deducted from an individual’s estate value. 

If a person leaves 10% of the net value of their estate to charity, the 40% IHT rate reduces to 36%.


  • Give away assets that are free from Capital Gains Tax

Assets that have devalued since purchasing them may be given away to reduce the value of the estate. No capital gains tax is applicable. 

Should the value of the assets recover, the gain would accrue in the estate. However, the growth would be IHT-free if ownership changed at least seven years before the date of death.

  • Spend it

If one’s estate incurred 40% inheritance tax, an alternative way of avoiding such tax would be investing in oneself. Spending one’s hard-earned money not only reduces one’s tax liability but also encourages individuals to enjoy the fruits of their labour.

Before an individual considers how to reduce the IHT liability, he needs to work out the exposure as a worst-case scenario. Online IHT calculators are easily accessible, however: for one-to-one assistance, call 020 3697 1700 or visit www.londonstonesecurities.co.uk