How To Beat The Five-Year Inheritance Tax Freeze

Tax Worldwide illustration

British expats could pay inheritance tax on their worldwide assets even if they have lived abroad for many years.

IHT follows domicile, and even long-term expats may fall foul of the tax if they have not pursued a domicile of choice in another country after leaving the UK.

In his Budget 2021, Chancellor Rishi Sunak froze IHT allowances for five years, and the measure is expected to raise an extra £1 billion for The Treasury.

But there are ways to beat the IHT tax trap for expats.

Inheritance Tax explained

Inheritance Tax or IHT is a tax on your personal wealth when you die.

If you are UK domiciled, IHT is due on your worldwide estate at a rate of 40% for pound you leave above the nil-rate bands.

House prices drive the tax grab

The main problem faces expats who own residential property in the UK.

If prices go up, the amount of IHT paid rises.

But if house prices go down, executors administrating expat estates can reclaim any overpaid IHT by invoking a little known rule.

The Office of Budget Responsibility – the independent oversight number crunchers who check the Chancellor’s Budget figures – reckon house prices will fall when the current stamp duty holiday ends, only to rise significantly by the end of the IHT allowance freeze.

The OBR house price forecast shows values will rise 5.7% this year, drop 1.7% in 2022 and then climb 0.8% in 2023, up another 3.9% in 2024 and carry on increasing by another 4.3% in 2025.

How will this impact house prices?

The Land Registry puts the current average price of a UK home at £251,500. Taking this figure, this is how the OBR forecast affects that value during the IHT freeze:

YearOBR house price forecastAverage house price

The figures show the price of a house will rise 13.5% during the freeze.

The IHT nil-rate bands

IHT has two nil-rate bands – one for the general estate and another for someone’s main home.

The main home nil-rate band applies to expats even though they have a main home in another country.

During the freeze, the nil rate bands for an individual are:

  • £325,000 standard nil-rate band
  • £175,000 main residence nil-rate band

If unused and passed to a spouse, the rates are doubled up on the second death. That gives a maximum nil rate band of £650,000 for a general estate and an extra £350,000 for the main family residence – a total of £1 million.

The bad news is the average London house price is already £514,000, according to the Office for National Statistics. Add 13.5%, and that makes the average home in the capital worth £583,390 by 2025.

It doesn’t leave much tax saving wriggle room for buy to let or second homeowners with two or more properties.

How to beat the IHT freeze

The first step in avoiding IHT is understanding how the system works.

To do that, you need to carry out a personal audit to reveal your net worth – the value of everything you own less what you owe.

Once you have carried out this exercise and know the extent of any IHT problem you may face, it’s time to take stock of what you can do to reduce the tax bill.

Passing on an offshore pension

Expats with a Qualifying Recognised Overseas Pension Scheme (QROPS) can pass any unspent fund on their death to their family free of IHT.

The same applies to a Qualifying Non-UK Pension Scheme (QNUPS) or international self-invested pension plan (SIPP).

Under UK law, pensions are not part of someone’s estate when calculating IHT.

Another tip is the pension lifetime allowance (LTA) does not apply to QROPS or QNUPS. The LTA is frozen for five years as well. This lets QROPS savers break through the £1.07 million pension limit without penalty.

Make your pension the last money to spend

Make a priority spending list for retirement and put your pension as the last thing to spend in retirement.

That way, you diminish your net worth subject to IHT and leave your cash that does attract IHT for your loved ones when you die.

Give away all the money you can afford to do without

Gift your spare cash derived from income that does not impact your standard of living rather than keeping it in the bank. This money is exempt from IHT and not included in your net worth.

These gifts are still free of IHT even if you die within seven years of making the gift under the potentially exempt transfer (PET) rules.

Maximise your spouse’s pension

If you do not have a QROPS but still have cash in an onshore pension or international SIPP, you can stash any spare cash in your spouse’s pension to double the £1.07 million cap.

You won’t get tax relief on the contributions as an expat, but you won’t pay the 40% IHT rate on the same money left in the bank either.

Claim overpaid IHT on property

Your executors can reclaim IHT paid on the disposal of a property if the price goes down within four years of your date of death.

IHT is worked out on the value of the property on the date of the owner’s death. If the value goes down in the following four years, executors can claim a refund.

The OBR forecasts prices may fall in 2022 and may not recover until 2024. Any excess IHT paid against buy to lets or second homes can be refunded if that’s the case.

For example, a buy to let is valued at the average price of £265,835 on death and drops to £261,316 a year later. On the other hand, the IHT on the date of death is £106,334 but falls to £104,526 a year later – a difference of £1,808 that is reclaimable.

The refund is not automatic but must be claimed.

The same rule applies to any loss in value on the sale of shares.

Inheritance Tax Freeze FAQ

IHT is one of the most complicated and least understood taxes, especially for expats who could still fall into the UK tax net even if they have lived overseas for decades.

Here are some answers to the most asked questions about how to avoid paying IHT legally.

What is the IHT freeze?

Chancellor Rishi Sunak has frozen all IHT allowances and reliefs until April 6, 2025. Normally, the limits would increase each year in line with inflation.

Does the main home nil-rate band apply to expats?

Yes, but you should speak to a local tax professional to determine if any local inheritance or death taxes apply.

Who can I pass my main home to?

The main residence relief comes with some caveats about passing on the family home. First, the rule only allows direct descendants to inherit. These are:

Children or grandchildren or lineal descendants, including step-children, adopted or fostered children or a child who the deceased was appointed as their guardian when they were aged 18 or under.

A husband, wife or civil partner of a lineal descendant (including a widow(er) or surviving civil partner

A lineal descendant is a blood relative in the direct line of descent.

Do I need to make a will to avoid IHT?

No. Intestacy laws apply without a will, but it’s always a good idea to clarify and explain your intentions in a will to avoid confusion.

Who can give estate planning advice?

A range of professionals offers estate planning advice, including tax advisers, lawyers and financial advisers.

What’s the difference between an IHT exempt gift and a PET?

Both types of gifts are defined in IHT law.

Exempt transfers are explained in the legislation, while Potential Exempt Transfers (PETS) are other gifts between individuals.

IHT exempt gifts include £5,000 towards the cost of a child’s wedding. Any extra cash would be a PET with IHT charged if the donor failed to live seven years after making the gift.

Find out more about IHT exempt gifts and PETS

Do I pay IHT overseas as an expat?

Many countries have some form of wealth tax on death. In the UK, it’s IHT. As an expat, you may be liable to local taxes and IHT in the UK, but the rules depend on where you are a tax resident and considered domiciled.
Domicile is different from tax residency.
Find out more about tax residency and domicile.

Below is a list of some related articles, guides and insights that you may find of interest.

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