Three simple inheritance tax mistakes could cost your family £100,000s – are you missing out?

Simple inheritance tax planning mistakes could be costing families hundreds of thousands of pounds, according to an IHT expert.

With inheritance tax (IHT) set to apply to pensions from April 2027, and the scrapping of 100% business property relief and agricultural property relief from April 2026, legacy wealth planning is becoming increasingly tricky.

Too often, people write a will but fail to consider inheritance tax planning at the same time, said Laura Rumsey, head of private client at law firm Rogers and Norton, a critical oversight when the IHT bill can claim up to 40% of everything they leave behind.

Try 6 free issues of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Worse still, the inheritance tax bill is often due before loved ones can access bank accounts or property. At a time of grief, families can find themselves trying to navigate IHT paperwork and scrambling to raise huge sums just to settle the IHT bill.

Rumsey said: “I regularly see families caught out by the same avoidable mistakes. These are not complex loopholes; they are straightforward steps that many people just don’t realise they need to take.

“By understanding the rules and planning ahead, families can protect what they’ve worked hard for and avoid leaving their loved ones with an unexpected and potentially devastating IHT bill.”

The marriage inheritance tax mistake

With UK marriages predicted to fall to historic lows, with just three in 10 people expected to marry by 2050, Rumsey warned many couples may not realise the financial consequences of cohabitation outside a legal agreement.

“If you are married and leave assets to your spouse, you are able to claim spousal inheritance tax exemption. This is important as the transfer between spouses on death means none of the estate is lost to inheritance tax,” she said.

Spousal exemption from inheritance tax allows assets to pass to the surviving spouse IHT-free, and “when the second spouse dies you will also have the availability of their unused tax-free bands,” potentially allowing families to pass on up to £1 million without inheritance tax.

But the law is clear: “Being married really is financially beneficial for tax planning and remember that legally there is no such thing as a common law spouse,” said Rumsey.

An unmarried partner inheriting a £500,000 estate could face a bill of around £70,000, “a costly shock many simply don’t see coming”, Rumsey pointed out.

The inheritance tax life insurance mistake

Thousands of families are overpaying inheritance tax on life insurance policies, because they make a simple mistake when they take them out.

Nearly 7,500 families paid inheritance tax on life insurance policies in 2022/23, according to HMRC. But many would have escaped a bill if their policy was written into trust.

A trust is a way of ringfencing your assets. When a life insurance policy is written in trust, the payout from the policy can be sent directly to your beneficiaries, rather than to your legal estate. This means they can avoid inheritance tax on the amount paid out from the policy.

Of the 31,500 estates that paid inheritance tax in 2022/23, nearly a quarter of them (7,458) included life insurance policies, according to HMRC figures.

These life insurance policies were worth a total of £865 million, meaning up to £346 million of inheritance tax may have been paid on them, if the full rate of 40% inheritance tax was due.

However, if the policies had been written into trust, they would not normally form part of the deceased’s estate and would therefore not be liable for inheritance tax.

Using a trust can also mean a speedier payout in the event of a claim, as the family won’t need to wait for probate, which can make a huge difference to dependants relying on the money to cover day-to-day bills.

Sean McCann, chartered financial planner at financial advice firm NFU Mutual, which analysed the figures, said: “Many people buy life insurance without advice, so aren’t aware that if they don’t put the policy in trust it’s included in their estate and could end up being taxed at 40%.”

Putting life insurance policies into trust is relatively straightforward. If you have life insurance and it isn’t in trust you can phone your provider and ask for a trust form.

“Provided you’re in good health when you put it into trust, there are normally no inheritance tax implications, as in most cases the policy has no value,” McCann said.

The only time when this wouldn’t be the case is if you are seriously ill when you put the policy in trust and die within seven years.

Under those circumstances, HMRC could argue the policy had a value when you put it into trust and seek to include that value in your estate and charge inheritance tax, McCann pointed out.

The inheritance tax two-year rule mistake

When wealth passes down through generations, there’s a real risk the same assets are taxed more than once. But many families don’t realise there is a legal way to adjust an inheritance after someone has died to help avoid IHT.

“Often people’s wealth can be generational and to avoid double taxation of the same assets it is possible to consider deeds of variation,” Rumsey, from law firm Rogers and Norton, said.

“These legal documents allow adult beneficiaries with mental capacity to change the distribution of their own inheritance to other people, usually their children for example.

“This means that the gift comes from the original deceased and can for example bypass a generation ensuring that wealth is passed on tax efficiently.”

Changing a beneficiary from an adult child to a grandchild doesn’t result in immediate inheritance tax savings, but it can potentially save 40% on the adult child’s eventual death by skipping a generation – meaning IHT is paid once, just by the grandchild, rather than twice.

Importantly, “these deeds of variation can be considered and prepared up to two years after the date of death which allows for careful planning before being actioned.”

That two-year window can make a substantial financial difference.