Inheritance tax tips: Eight ways to shield your family’s wealth

The nation’s most loathed financial levy may be inheritance tax but it’s a growing cash cow for the Government.

Families shelled out a record £6.1billion in death duties last year, up by £729million in the previous 12 months.

Experts say soaring house prices are partly to blame for pushing up the value of estates. 

At the same time, the threshold at which inheritance tax (IHT) kicks in has been frozen at £325,000 since 2009 — and is expected to remain the same until 2025/2026.

Inheritance tax: Families shelled out a record £6.1bn in death duties last year, up by £729m in the previous 12 months

It means more ordinary households could find themselves stung by the 40 per cent levy, which historically has affected only wealthier individuals.

It’s little wonder then that the subject of IHT has become a hot topic in the Conservative Party leadership contest.

Last week, Liz Truss promised to review the tax should she become Prime Minister. The pledge is a welcome relief to campaigners who say the system is too convoluted.

In January 2020, an all-party parliamentary group put together a white paper calling for a reform of IHT — labelling it a ‘deeply unpopular tax’. But, no change has been made in the two-and-a-half years since. 

Currently, IHT is payable when the value of your estate exceeds £325,000. Any gifts you make in the seven years prior to your death will be considered part of your estate by HMRC.

This is known as the ‘seven-year rule’. If you do die within this timeframe, tax will be levied on a sliding scale, starting at 40 per cent within the first three years.

Assets left to a spouse or civil partner are exempt. In these cases, your tax-free allowance is passed onto them, doubling it to £650,000.

What’s more, if you are leaving property to a direct descendant, such as a child or grandchild, you will also benefit from the £175,000 ‘main residence nil-rate band’.

In total, couples can give up to £1million to loved ones before inheritance tax is due.

These clunky rules can make for overwhelming reading. So Money Mail has asked a host of tax experts to share eight tricks to help shield your family’s wealth from the taxman….

My 86-year-old grandfather is making large cash gifts to family members – will we have to pay IHT?

This is Money’s resident tax expert Heather Rogers replies to a reader – find out how to ask her your question here.

Give it away now 

Gifting up to £3,000 a year tax-free forms part of your ‘annual exemption’. This can be given to an individual or split between several. Or you can carry the unused amount forward for one tax year.

You can also give £250 to as many people as you want each tax year, as long as you have not utilised another allowance to give cash to the same person.

Regular income

The taxman will not charge you for regular payments made to loved ones from your surplus income. This can be ‘relatively straightforward’, says Kieran Bowe, from The Law Society wills and equity committee.

Acceptable forms of income include your pension or money earned through renting out property. There is no cap on how much you give but it cannot affect your standard of living, so should only be given after you have paid for all of your other living expenses.

You must be able to show these payments were made regularly — monthly, annually or bi-annually.

They are covered by the ‘normal expenditure out of income’ exemption, so not subject to the seven-year rule.

What you need to know about IHT 

Inheritance tax may only affect a small number of estates but it can lead to bills of hundreds of thousands of pounds for the families that do pay.

In our guide to inheritance and ten tips to avoid IHT we explain how the tax works and what you can do to mitigate its effects.

There are many legal ways to cut the impact of the dreaded 40 per cent ‘death tax’ if you want to pass on the maximum sum possible and are prepared to plan ahead. 

Many, such as spending more on yourself and making early gifts to family, can be undertaken easily by any ordinary person without the need for elaborate arrangements or to pay for professional help.

However, if you know your estate will face a large inheritance tax liability and that concerns you, it could be worth seeking professional help from a financial planner or adviser. 

To work out whether you need advice, planning, or coaching, the following links can help you understand more:

> Financial adviser, planner or coach – what’s the difference? 

> Financial advice: What to ask and how much it might cost 

> Find a financial adviser service

Wedding gifts

You can donate up to £5,000 to your child’s big day without it being included in your annual giving allowance. For a grandchild or great-grandchild, you can give £2,500. The allowance drops to £1,000 for anyone else.

Check pension 

Any funds remaining within defined contribution pensions after you die fall outside of your estate and are exempt from IHT.

Although this is not the case if you have already purchased an annuity.

If you are a member of a defined benefit scheme, there is no ‘pot’ to pass on but there may be a provision made for a spouse or dependants.

Pensions are ‘invaluable’ for reducing IHT bills, says Anthony Kynaston, from asset manager Ash Ridge, so be sure to review your policy regularly.

Be charitable

Donating up to 10 per cent of your estate to a charity or political party means the rate of inheritance tax due on your remaining wealth drops from 40 pc to 36 pc.

All charitable giving is tax-free, so any donations from your estate will reduce the IHT bill.

Invest wisely 

If you choose to invest in firms listed on the specialised Alternative Investment Market (AIM), which caters to smaller, more risky companies, tax may not be owed if you die within two years of making the investment — rather than seven.

This can be risky as stock markets are volatile and you could lose money. But John McCaffery, from accountancy firm Alexander & Co, says: ‘You would have to be more than 40 pc down for you to be worse off than being landed with an IHT bill.’

Life insurance

A life insurance policy can ensure a quick, tax-free payout for your family. The money would usually form part of your estate — but not if you have it written ‘in trust’. This allows you to appoint one or more beneficiaries who will be paid the full sum when you die. You can insure your life for the estimated value of your IHT bill.

However, premiums can be high — especially as you get older. You may want to ask a financial adviser for help making this type of arrangement.

Set up a trust

A trust can allow you to transfer your wealth over time, says Natalie Jaques, from investment management firm Sanlam. You can place £325,000 of your tax-free allowance into a trust — or £650,000 if you combine it with a spouse or civil partner.

The money placed in the trust will not be included in your taxable estate when you die — though it is subject to the seven-year rule. After seven years, you can transfer another £325,000 — or £650,000 if a couple.

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