Inheritance Tax Planning: Reduce What Your Family Pays

Inheritance tax is the tax your family pays when you die. In the UK, it’s 40% on everything above £325,000 (or £500,000 if you’re leaving a home to your children). In the US, it’s 40% on estates over $13.61 million. In Canada, there’s no inheritance tax — but the tax bill can still be brutal.

Understanding how these taxes work — and planning for them — can save your family tens of thousands.

How Inheritance Tax Works

United Kingdom

The UK inheritance tax system is straightforward but punishing if you don’t plan.

Nil-Rate Band:

• First £325,000 of your estate is taxed at 0%
• Anything above this is taxed at 40%
• This has been frozen since 2009 — and is set to remain frozen until 2028

Residence Nil-Rate Band:

• Additional £175,000 if you leave your main home to a direct descendant (child, grandchild, etc.)
• This means a couple leaving their home to children can shelter up to £1,000,000 tax-free

Reduced Rate:

• If you leave 10%+ of your estate to charity, the rate drops to 36%

Exemptions:

• Spouses and civil partners inherit tax-free (no limit)
• Gifts made more than 7 years before death are exempt
• Annual gift allowance of £3,000 per year (plus £250 small gifts, and gifts for weddings/births)
• Gifts from surplus income are exempt if you can afford them from your normal income

United States

The US estate tax is less of a concern for most people because the exemption is so high.

Federal Estate Tax:

• Exemption: $13.61 million per individual (2024 figure — projected to increase with inflation through 2026)
• Rate: 40% on everything above the exemption
• Married couples can combine exemptions (up to $27.22 million)
• Portability: the unused portion of a deceased spouse’s exemption can transfer to the surviving spouse

State Estate Taxes:

• 12 states and Washington D.C. have their own estate taxes with much lower exemptions
• Massachusetts and Oregon: $1 million exemption
• New York: ~$7 million exemption
• Washington: ~$2.2 million exemption
• These are where most people get caught out

Gift Tax:

• Annual gift exclusion: $18,000 per recipient (2024)
• Lifetime gift tax exemption: $13.61 million (same as estate tax exemption)
• Gifts above the annual exclusion reduce your lifetime exemption

Canada

Canada has no inheritance tax, but that doesn’t mean your family escapes taxation.

Deemed Disposition at Death:

• When you die, the CRA treats you as if you sold all your assets at fair market value
• Capital gains tax is owed on any increase in value
• The inclusion rate for capital gains above $250,000 is 66.67% (as of 2024)
• The first $250,000 of capital gains each year is taxed at 50%

Registered Accounts:

• RRSPs and RRIFs are fully taxable on death — the entire balance is added to your income
• TFSAs are tax-free — they pass to your beneficiary without tax
• If a spouse is named as beneficiary, RRSPs/RRIFs transfer tax-free

Provincial Probate Fees:

• Ontario: 1.5% on estate value over $50,000
• British Columbia: 1.4% on estate value over $50,000
• These are separate from income tax

Planning Tips to Reduce the Tax Bill

1. Gift During Your Lifetime

The most powerful tool is giving money away while you’re alive.

UK:

• Annual gift allowance: £3,000 per year (you can carry forward one year, so £6,000 in year one)
• Small gifts: up to £250 per person per year (unlimited number of recipients)
• Wedding gifts: £5,000 for a child, £2,500 for a grandchild, £1,000 for anyone else
• Gifts from surplus income: no limit if you can show they come from your regular income

US:

• Annual exclusion: $18,000 per recipient per year (2024)
• Married couples can give $36,000 jointly
• Tuition and medical expenses paid directly to the institution are exempt
• Gifts to your spouse are unlimited

Canada:

• No gift tax — you can give money freely during your lifetime
• Capital gains still apply if you gift appreciated assets
• Gifting to a spouse is tax-neutral (spousal rollover)

2. Trust Funds

Trusts can keep assets outside your estate for tax purposes.

UK Trusts:

• Discretionary trust — trustees decide who gets what and when. Effective for IHT but complex to set up
• Bare trust — beneficiary has an immediate right to the assets. Included in your estate but useful for gifting to children
• Interest in possession trust — beneficiary gets the income but not the capital
• Pilot trust — set up with a small amount, then additional assets can be added later (but watch for the “gift with reservation” rules)

US Trusts:

• Revocable living trust — you maintain control during your lifetime, avoids probate but doesn’t reduce estate tax
• Irrevocable life insurance trust (ILIT) — life insurance proceeds are excluded from your estate
• Generation-skipping trust — passes wealth to grandchildren, skipping estate tax on your children’s estates
• Qualified personal residence trust (QPRT) — lets you transfer your home out of your estate at a reduced gift tax value

Canadian Trusts:

• Alter ego trust — for people 65+, can hold assets outside the estate
• Joint partner trust — similar, for married couples
• Trusts in Canada are taxed at the top marginal rate, so they’re mainly useful for asset protection, not tax reduction

3. Life Insurance

Life insurance can pay the inheritance tax bill directly, so your family doesn’t have to sell assets.

UK:

• Write life insurance in trust — this means the payout doesn’t form part of your estate
• Level term assurance can be timed to cover potential IHT liability
• Premiums are not tax-deductible, but the payout is tax-free if in trust

US:

• Life insurance proceeds are generally tax-free to beneficiaries
• If you own the policy, the proceeds are included in your estate — so consider transferring ownership to an ILIT
• Second-to-die policies are popular for married couples — they pay out when the second spouse dies, covering the IHT bill

Canada:

• Life insurance proceeds are tax-free to the beneficiary
• Can be used to offset the tax hit from RRSP/RRIF deemed disposition
• CPP death benefit ($2,500) is taxable; life insurance is not

4. Pension Nominations

In the UK, pensions are outside your estate for IHT purposes — making them one of the most tax-efficient ways to pass on wealth.

UK Pension Death Benefits:

• If you die before 75: pension passes tax-free to your nominated beneficiaries
• If you die after 75: beneficiaries pay income tax on withdrawals (at their marginal rate)
• Nomination is crucial — without it, the pension scheme decides who gets it
• You can nominate anyone: spouse, children, friends, charity

US 401(k)/IRA:

• Beneficiary designations override your will — make sure they’re up to date
• Spousal beneficiaries can roll over into their own IRA (tax-deferred)
• Non-spousal beneficiaries must withdraw within 10 years (SECURE Act)
• Naming your estate as beneficiary triggers probate and delays

Canada RRSP/RRIF:

• Spousal designation allows tax-free transfer
• Minor children: can designate to receive income until age 18 (with some tax advantages)
• Charitable designation: estate gets a tax credit for the donation

Calculation: UK Inheritance Tax on a £500,000 Estate

Let’s work through a realistic example.

Estate Details:

• Main home: £350,000
• Savings and investments: £100,000
• Personal possessions: £50,000
• Total estate: £500,000

Leaving to: Adult children (direct descendants)

Tax Calculation:

Result: No inheritance tax payable. The nil-rate band plus residence nil-rate band covers the entire estate.

But what if the estate was £600,000?

What if they leave £60,000 to charity?

Savings from charitable bequest: £25,600.

When to Start Planning

The earlier you start, the more options you have — especially with the 7-year rule on gifts in the UK.

Start now if:

• Your estate is close to or above the threshold
• You’re over 55 and haven’t made a will
• You own property with significant equity
• You have savings, investments, or pensions
• You want to leave money to people who aren’t your spouse or children
• You own a business

Review your plan every 3–5 years or after major life events: marriage, divorce, birth of children, inheritance, property purchase, or change in health.

Common Mistakes

1. Not making a will — without one, you lose control over how tax is minimised
2. Forgetting pension nominations — the default may not be who you want
3. Giving away too much too late — gifts within 7 years of death are still included in your estate (UK)
4. Ignoring state-level taxes — in the US, the federal exemption is high but state exemptions can be as low as $1 million
5. Not using life insurance in trust — an unprotected policy can add to your estate value
6. Failing to consider capital gains tax — in Canada, deemed disposition at death can create a large tax bill even without inheritance tax

Next Steps

1. Value your estate — add up everything you own and subtract debts
2. Check the thresholds — compare against your country’s nil-rate band or exemption
3. Consider gifting — use your annual allowances while you can
4. Review pension and insurance nominations — make sure they’re current
5. Get professional advice — for estates over the threshold, a financial adviser or tax specialist can save your family far more than they cost
6. Write or update your will — your plan is only as good as the will that implements it

Inheritance tax planning isn’t about avoiding tax — it’s about making sure your family keeps as much of your hard-earned money as possible, rather than handing it to the government.