Planning inheritance can feel like navigating a maze—especially with the UK’s inheritance tax (IHT) system, which taxes estates at 40% above the £325,000 nil‑rate band. But smart families are legally saving over £175,000 using a combination of allowances, trusts, and pensions. Let’s break it down—and yes, there’s a real loophole here.
💡 What Is the “Shocking” Loophole?
The true £175,000+ saving often comes from combining two allowances:
- The £325,000 nil‑rate band (everyone’s base)
- The £175,000 residence nil‑rate band (for passing your home to descendants)
—Summing up to £500,000 per person, or £1 million for couples.
Families legally preserve this £175,000 by:
- Transferring assets/pension pots out of the taxable estate, and
- Using trusts and giving away assets early, so only the home band applies at death.
Let’s explore key strategies:
The Power of Pensions: “Pension Exemption”
Why it works: UK pensions are not included in your IHT estate—even though they can be substantial. If you pass away before age 75, beneficiaries can receive the entire amount tax-free. This was recently championed by Martin Lewis and MoneySavingExpert for its IHT benefits .
How families use it:
- Max out pension contributions instead of saving cash.
- Withdraw from pensions gradually in retirement—but leave the bulk untouched.
- At death, the pension pot bypasses IHT entirely, preserving more room for the £175,000 residence allowance.
Trusts: Protection and IHT Relief
Trusts let you remove assets from your estate while still providing benefits. Recent budget changes have prompted more families to set them up (The Times), particularly discounted gift trusts, which offer both income and IHT savings (Wikipedia).
| Trust Type | IHT Benefit | Notes |
|---|---|---|
| Bare Trust | Immediate removal of asset from estate; child controls asset at 18 | No ongoing trust charges |
| Discretionary Trust | Remove estate assets; trustees decide distributions | 20% charge above £325k, plus 6% every 10 years |
| Discounted Gift Trust (DGT) | Immediate IHT “discount” by retaining a life-income right (The Guardian, Wikipedia, Study Points, The Times) | Best for those wanting income and legacy planning |
Why it’s effective:
- Assets move out of your estate (up to £325,000 each every 7 years).
- Couples can combine allowances to shield £650,000 every 7 years from IHT.
- A DGT gives you income despite gifting capital, with immediate IHT relief.
Early Gifting + 7-Year Rule
By gifting cash or assets more than 7 years before death, you ensure they fall outside your estate.
How to do it right:
- Use the annual £3,000 exemption yearly per person.
- Make small £250 gifts to several individuals.
- Give more, then wait seven years—no IHT on those assets.
- Use taper relief (40% → 0%) if death falls within 3–7 years (GOV.UK).
Residence Nil‑Rate Band & Freezing Thresholds
The £175,000 residence allowance is precious—but it tapers for estates over £2 million (Today’s Wills and Probate). With property values rising, families use IHT strategies like trusts and pension contributions to keep estate value just below £2m, securing the full band and avoiding wastage.
Let’s Break It Down: How to Save +£175,000
- Maximise Pensions:
Contribute to private/work pensions—outside IHT. If done decades before death, your pension pot escapes taxation. - Use Trusts for Liquid Assets:
- Set up a discounted gift trust with savings/investments.
- Keep income; the remainder transfers tax efficiently.
- Gift Surplus Income:
Make annual or periodic gifts from excess income, using exemptions without affecting capital. - Monitor Residence Threshold:
Ensure total estate (excluding pensions/trusted assets) stays under £2m to lock in home allowance. - Leverage Spousal Exemptions:
Transfer to your spouse first—then they funnel assets into trusts/pensions using their allowances. Fully utilizes both £500k allowances.
Comparison Table: Common IHT Tools at a Glance
| Strategy | IHT Benefit | Best For | Pros / Cons |
|---|---|---|---|
| Pension Contributions | Removed entirely from IHT estate | Anyone with a pension plan | High annual limits; cannot access funds early |
| Discounted Gift Trust (DGT) | Income retained; capital is gift-taxed with an immediate IHT discount (Study Points, Wikipedia, MoneyWeek, Today’s Wills and Probate, The Times, The Times) | Later-life assets + income needs | Setup costs; trust admin; possible IHT charges |
| Bare/Discretionary Trusts | Removes up to £325k each 7 years; flexible control | Families wanting asset protection | Periodic trust charges; complexity |
| 7‑Year Gifting + Taper Relief | Gifts older than 7 years are IHT-free | Those with surplus capital ready to give | Risk if death <7 years, taper relief may apply |
| Pension vs. Estate Balancing | Use pensions to shrink estate under £2m, preserving £175k band | High-net-worth homeowners | Requires careful planning around growth & death |
Implications & Caveats 👇
- Regulatory changes loom. Chancellor Rachel Reeves is weighing extending the 7‑year rule to 10 years and reforming AIM/pension exemptions (Financial Times). That could alter the landscape by 2027.
- HMRC scrutiny is real. Large gifts or trust setups may invite investigations (Financial Times). Keep excellent records and proper legal advice.
- Trusts aren’t perfect. Administration and setup costs can run thousands (The Times), so ensure long-term benefits outweigh expenses.
- Family dynamics matter. Gifting reduces flexibility; changing circumstances (divorce, bankruptcy) can complicate plans.
- Policy backlash possible. High-value users of loopholes might face future tightening, especially amid calls for fairer wealth distribution.
Key Insights & Final Thoughts
- The real breakthrough isn’t a secret trick—it’s smart use of existing allowances (pensions, trusts, allowances).
- Pensions are the cornerstone—build them up not just for retirement, but as IHT shields.
- Trusts, especially DGTs, help protect both assets and family interests.
- Gift now, wait seven years to remove assets for good.
- Combine allowances within couples to maximize the £1m relief.
- Stay ahead: be prepared for possible 7‑to‑10 year rule changes or trust reforms in 2026–27.
What You Can Do Today
- Ask a qualified IHT adviser to review your estate.
- Calculate your current estate value, excluding pensions.
- Set up pension top‑ups with an eye on long-term growth.
- Draft basic trusts, even simple bare trusts, before April 2026 changes.
- Use annual gift exemptions and small, regular gifts from income.
- Monitor legislation—the next Budget may reshape these strategies.
Conclusion
The “shocking” loophole is actually a well-crafted combination of allowances—and when done correctly, legally saves families over £175,000. By focusing on pensions, trusts, gifting strategies, and smart use of the residence nil-rate band, you can significantly lighten the IHT burden—and keep more wealth in your family’s future.
But these strategies aren’t ‘set and forget’. They require planning, coordination, and regular review—especially as policies shift. Act now, and you could safeguard hundreds of thousands for your loved ones.
Disclaimer: This blog is for educational purposes. Always consult a certified tax advisor or solicitor before making financial decisions.
