Planning ahead to take the sting out of inheritance tax

PUBLISHED: 13:02 26 January 2006 | UPDATED: 11:28 04 May 2010

Rosemary Langley, private banking manager, Lloyds TSB Private Banking, Cambridge has some top tips on inheritance tax. With rising property prices, inheritance tax (IHT) is affecting an increasing number of people. There are an estimated 2.4 million ho

Rosemary Langley, private banking manager, Lloyds TSB Private Banking,

Cambridge has some top tips on inheritance tax.

With rising property prices, inheritance tax (IHT) is affecting an increasing number of people. There are an estimated 2.4 million homes that are now valued above the £275,000 threshold and it is predicted that by 2009, 3.6 million estates will be liable for IHT.

Inheritance tax is the tax you pay on 'transfers of value' or broadly speaking, gifts. When you die, everything you own at the time is treated as a transfer of value including your home, investments, car, bank accounts and the value of all transfers of value made in the seven years up to your death. Any estate worth more than £275,000 is taxed at 40 per cent and last year, a staggering £2.9 billion of inheritance tax was paid to the revenue.

With such a potentially large tax bill looming, it's important to take time to sit down and work out if inheritance tax will be an issue for you by adding up the value of your savings, investments, property and personal possessions. Don't forget to add PEPs and ISAs as although they are tax free in your lifetime they will count towards inheritance tax. Finally, take off the value of any debts. If the total adds up to more than £275,000 then it's likely your estate will be subject to inheritance tax.

What next? Write a will

If you are keen to avoid inheritance tax, there are a number of steps you can take. Firstly, if you haven't done so already, write a will. It makes your wishes clear and stops any assets being divided under the rules of intestacy where even spouses and civil partners are not guaranteed to inherit everything. It can also be the first step to reducing an inheritance tax bill. Many married couples and civil partners draft wills that pay part of their wealth into a trust when the first of them dies. The survivor can benefit from the legacy, but so can others such as children and grandchildren.

Ensure that your estate

is as small as possible

You can't be taxed on money that was never yours so ensure that as much as possible is outside your estate. Write any new life insurance plans under a trust. Many existing life policies can be transferred into a trust and if your employer pays a death benefit, complete a nomination form to make sure that any money goes directly to the person you choose and not into your estate. It is also worth thinking about legacies you receive. Someone who benefits from a legacy can divert that gift to another person.

If you are living together, make it formal

Legacies between un-married couples or same sex couples not recognised under a civil partnership are not tax free however anything you pass on to a spouse or civil partner is free of inheritance tax.

Set up trusts

Depending on the type of trust you choose, it can still be possible to enjoy an income from money paid into trust even though you are no longer the legal owner of that cash. However, if you are thinking about setting up a trust it's essential to get expert advice.

Pay tax in instalments

Another option is to estimate how big an IHT bill your heirs face then arrange insurance to cover part or all of it. Whole of life insurance written under trust can provide a lump sum on death that is outside an estate. On death, the proceeds of the policy can be used to settle the tax bill.

Use annual allowances

Giving money away will reduce your estate but won't necessarily cut your tax liability as you have to survive for seven years for most gifts to escape the IHT net. The Revenue allows gifts of up to £3,000 each tax year. Unlimited gifts up to £250 a person per tax year are exempt, as are payments up to £5,000 for wedding gifts. Also, gifts made from normal income can be exempt from IHT.

There are a number of ways to minimise inheritance tax, but think ahead and don't leave it to the last minute. Take professional advice and depending on your ultimate objectives there should be a solution for you.

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