Inheritance Tax, A Concise Guide

With ever-increasing property prices, more and more people's assets are now worth more than the inheritance tax threshold of £285,000, which has never been increased in proportion to the recent property boom. With a rate of 40% inheritance tax on any assets above the £285,000 threshold in the estate, this can really put a dent in what your heirs receive from your estate.

Inheritance tax is levied upon a person's death. Once all of their assets have been totalled up, anything over the threshold will have to be paid by the executors of their will.

It's becoming increasingly difficult to avoid inheritance tax, but there are some strategies that you can put in place to help minimise its impact. Inheritance tax is an extremely complicated subject, though, so you should never attempt to make any plans yourself without good professional advice, otherwise you may end up making your tax situation worse.

Make a will

First, make a will. This in itself won't help you to avoid inheritance tax, but it will make your intentions clear so that any inheritance tax planning you have put in place will come into effect.

Transfers between spouses

If you're married or in a civil partnership, both of you should attempt to use your full threshold separately.

Husbands and wives or civil partners can transfer assets (such as property) to each other without incurring inheritance tax. However, this will increase the value of the surviving partner's estate, which will be subject to tax when they die. If this brings it above the threshold, inheritance tax will then be due. Another possibility is to bequeath your estate to someone other than your spouse, for example your children. However, this has its own complications and is not always appropriate.

Gifts

If you want to give something away during your lifetime but still keep using it, the Inland Revenue may still consider it part of your estate for tax purposes when you die. Such gifts are regulated under the ‘inheritance gift with reservation' rules. For example, if you sold your house to your children you may have to pay full market rent. Also, they could be liable to pay capital gains tax on it if it is a second property for them.

However, within certain guidelines you can give away some assets and gifts to friends and relatives, known as ‘potentially exempt transfers'. These will not be subject to inheritance tax as long as they are given at least seven years before you die. If you die within seven years of giving a gift, tax will have to be paid on a sliding scale.

Some gifts are completely exempt from the inheritance tax rules. You can gift up to £3,000 in any tax year, plus up to £3,000 in unused allowance from the previous year. Unused allowance can only be carried forward from one previous year. There's also an allowance for wedding gifts to children (up to £5,000 for each child) and grandchildren (up to £2,500 per grandchild) and other friends and relatives (up to £1,000). A small gift allowance of £250 per recipient per year is also permitted.

Some gifts, however, may be subject to capital gains tax if any income is made from them, e.g. if they are invested in stocks and shares.

Gifts to charities

Gifts to registered charities and political parties are always exempt from inheritance tax.

Trust funds

In some circumstances, it's possible to set up a trust fund. However, the rules regarding trust funds were changed in the 2006 budget to restrict inheritance tax avoidance in this way so it's not always a feasible option. Most money held in trust for children will be subject to inheritance tax after they reach 18 unless they are disabled.

Life policies

Certain types of life policy are exempt from your estate under inheritance tax rules. So, it may be possible to pay regular sums into such a policy, either towards a trust or towards your children, in the hope that it will make enough money to pay some or all of the inheritance tax bill at the same time as reducing the size of your taxable estate.