Hundreds of thousands of households are at risk of paying inheritance tax (IHT). The much-hated tax is charged at 40 per cent on the value of your estate over the nil-rate band threshold – £325,000 for an individual and £650,000 for a married couple.
Once you factor in the family home, holiday properties, buy-to-lets, savings and investments, many people’s estates are now over this limit.
But there are ways to escape IHT Here we explain how:
Make a plan
Many families do not start thinking about IHT planning until it is too late, so the first thing to do is to work out if the tax will be an issue.
Add up the value of your savings, investments, properties and other personal possessions. Don’t forget to include funds held in an Isa or Pep wrapper. Although they are tax-free during your lifetime, they are subject to death duties.
Then check how much the nil-rate band threshold is in the current tax year. You only pay tax on the value of your estate over this threshold. In the 2009-10 tax year the threshold is £325,000.
IHT is not payable when an estate passes between a husband and wife, or from one civil partner to another. Even better, married couples or civil partners can transfer the unused element of their IHT-free allowance to their spouse when they die.
A couple would escape tax on £650,000 by doubling up the allowance this financial year. In April 2010, when the nil-rate band threshold rises to £350,000, a married couple would escape tax on £700,000.
Give away assets
Giving away assets during your lifetime is a simple and legitimate way to take the sting out of death duties, as long as you do it in time. You can gift up to £3,000 a year and it is immediately exempt from IHT, or £6,000 if you did not make a gift of this kind in the previous tax year.
A married couple giving for the first time could, therefore, hand over £12,000 to their children in one year. After that, the maximum for a couple is £6,000.
You can also escape IHT by giving £250 to any number of people every year, but you cannot combine it with the above exemption.
Parents can give £5,000 to each of their children as a wedding or civil partnership gift. Grandparents can give £2,500 and anyone else £1,000.
Gifts of any size to political parties or charitiesare also exempt.
If a gift is regular, comes out of income and does not affect your standard of living, any amount of money can be given away and ignored for IHT.
Live for seven years
It is possible to make further tax-free gifts known as potentially exempt transfers (Pets), but you have to survive for seven years after making the gift.
If you die within seven years and the gifts are valued at more than the nil-rate band threshold, you apply taper relief. The tax reduces on a sliding scale if the gift was made between three and seven years earlier.
Say you had given your daughter £425,000 and die this year. After deducting the 2009-10 allowance of £325,000, you are left with a chargeable gain of £100,000. If the gift was made five years before your death, she would pay a rate of 16 per cent on the gain – £16,000.
If you cannot apply taper relief, you usually add the gift to other assets and pay 40 per cent on the sum above the £325,000 threshold. For example, if the gift is worth £425,000 and your estate is worth £300,000, you would pay 40 per cent tax on £400,000.
You can give away most assets, including cash and shares. However, it has to be an outright gift from which you can no longer benefit. This excludes giving away your family home. If you hand it to your children and continue to live there, you have to pay a market rent, which can wipe out the tax benefits.
Always make a note of such gifts to pass on to the executor of your will.
Try gift or loan schemes
Loan trusts are designed for people who cannot give away assets because they need to live off the income but want future investment growth to be IHT-free.
You make a payment to a trust, which is treated as an interest-free loan to the trustees. The trust then repays your loan capital in instalments, giving you an income. When you die, any outstanding loan forms part of your estate, but all investment growth is free from tax.
If you need to draw an income but do not think you will need the capital, look at discounted gift trusts sold by banks and insurers. You make a gift into a single-premium insurance bond for your children, fixing how much income you will draw until your death. If you survive for seven years, the bond does not count as part of your estate.
Before investing in one of these schemes seek advice from an independent financial adviserwho specialises in tax planning.
Some investments offer tax benefits. Most shares listed on the Alternative Investment Market become free from IHT once you have held them for two years. This is because they qualify for business property relief. There are risks, as AIM stocks can be extremely volatile, but the value of your portfolio would have to fall by 40 per cent or more before you would lose the IHT benefits.
Fund managers and stockbrokers can build a portfolio for you. Taxefficientreview has a list of firms that can help.
Money invested in a commercial forest or actively farmed land also becomes free of IHT after you have owned it for two years. Commercial woodland is defined as property where timber from the forest will be actively marketed and sold.
Whether a farmhouse escapes IHT is a grey area. In 2005 land-tribunal judges said that they should be exempt only if the owners or their spouses had farmed the land on a daily basis. Lifestyle farmers not involved in the daily running could be barred.
The key to avoiding IHT is to act early. Early could mean now. If you require any advise please contact us.