Don't leave your money to the taxman

It's not surprising that inheritance tax (IHT) is often described as one of the most hated taxes. At 40% of anything you own in excess of the nil rate band (£325,000 in 2014/15), it can swallow up a significant chunk of your wealth.

But while the taxman collected more than £3 billion in IHT in the 2012/13 tax year, Frank Cochran, managing director of independent financial adviser FSC Investment Services, says it should be regarded as a voluntary tax.

"The only people who pay IHT are those who love the taxman more than their own children," he says. "If you take the time to plan, you can avoid leaving your loved ones with an IHT bill."

The starting point is to add up the value of all your worldwide assets, including property, savings and investments, valuables and your share of any jointly owned ones.

Deduct from this any debts and the nil rate band and the taxman will be expecting to take 40% of what remains.

Some additional relief is available for married couples and civil partners. Under the transferable nil rate band rules, any remaining allowance can be passed to the surviving spouse for use on their death. This means a widow or widower dying this year could have a nil-rate band of up to £650,000.

But, whether married or not, if the value of your assets result in a future IHT liability, there's plenty you can do to reduce this. Craig Palfrey, certified financial planner at Penguin Wealth, says the most pleasant option is a spot of ‘skiing'.

"Skiing, short for spending the kids' inheritance, is a great way to reduce your estate as long as you don't buy assets that will add to its value," he says. "The big problem, though, is that as no one knows how long they're going to live, most people find this option unpalatable."

Giving it away

Rather than spend, many people prefer to give their wealth away to reduce a future IHT bill. This can be effective but requires time.

With most gifts, known officially as potentially exempt transfers (PETs), you need to live for seven years for it to be outside your estate for IHT purposes. You also need to give away all interest in it so this strategy wouldn't work if, for example, you give your son your home and carry on living in it.

Some gifts don't require this seven-year timeframe. Anything you give to a spouse, civil partner, charity or UK political party is immediately outside your estate. Some gifts will be immediately exempt from IHT.

As well as having an annual limit of £3,000 for large gifts, you can give away as many gifts worth up to £250 per person each year. Brides, grooms and civil partners to-be can also be tax-efficient recipients with parents and grandparents able to give up to £5,000 and £2,500 IHT-free respectively and others, up to £1,000.

While these gifts help to chip away at a future liability, one exemption that is potentially chunkier but is often overlooked is regular gifts out of normal expenditure. Providing you're giving away taxed income and you're able to maintain your normal lifestyle, any regular gifts will be immediately outside your estate.

"There's no limit on the amount you can give away and regular could be as infrequently as once a year," says Toby Alcock, senior client partner at Towry. "You might even want to divert it into junior Isas or pensions to increase the tax efficiencies."

With any gifts, documentation is essential. As these exemptions are claimed during probate, it's essential to leave your executors adequate paperwork to show your planning.


Although few of us mind how someone spends a £250 gift, giving away larger amounts can make many of us much more nervous. As well as potentially seeing it being frittered away, or carved up as a result of a divorce or bankruptcy, there's also the risk that you might need the money in the future.

Using a discretionary trust can address these issues. Any money you put into a trust is a PET so takes seven years to be outside your estate. However, rather than being given absolutely to someone it is up to the trustees, which would usually include you, to decide who receives it and when. This means you can delay giving it to avoid it being squandered or being part of a divorce settlement.

Trusts have also been packaged to make them suitable for different planning purposes. Palfrey explains: "Trusts are very flexible. As examples you could use a loan trust, where any growth is immediately outside your estate, or a discounted gift trust to give you access to an income from the fund."

While there are significant benefits, there are also some catches that you need to avoid.

If the value of a trust exceeds the nil-rate band (£325,000), you'll be hit with tax charges. These include a lifetime IHT charge of 20% on any excess if you pay in more than the nil-rate band, plus a periodic charge of 6% on the excess every 10 years.

Another nasty is the 14-year rule, as Palfrey explains: "It usually takes seven years for a gift you make into a trust to be considered outside your estate but, if you make another gift in that period, you restart the clock. Get your timing wrong and it could take as long as 14 years."


If you don't have so much time to dedicate to reducing a future IHT bill, or you are happy to take a little more risk, an investment strategy could also be an option.

Investments into qualifying Alternative Investment Market (Aim) shares and unquoted companies benefit from business property relief (BPR), putting them outside your estate after just two years.

There are potential catches, though. Danny Cox, head of financial planning at Hargreaves Lansdown, says the rules around qualifying assets can be tricky. "Broadly, investment companies and those in property and land development are excluded but you will only find out for certain during probate. This can be a bit too late to discover your investment didn't qualify for BPR," he says.

To take some of the uncertainty off your hands, you can use an IHT portfolio service put together by a stockbroker or investment firm. Again, though, there's no guarantee a company won't fall foul of the taxman's rules.

Another option is an Enterprise Investment Scheme (EIS), which, by investing in fledgling companies, offer income and capital gains tax breaks and also benefit from BPR after two years.

However, Cox says with all these IHT-efficient investments, you're not getting something for free: "The government has offered these tax incentives to encourage people to invest in these early-stage businesses. Liquidity is often poor and the chances of failure fairly high. If your investment holds its value and you get the tax breaks on top, you're doing well."

This means these investments are only really suited to people comfortable with high levels of risk, with advisers recommending they form no more than 10% of an investment portfolio. "You may have to weigh up whether you'd rather pay 40% of something or receive 100% of nothing," adds Alcock.


For a lot more certainty, insuring a future IHT bill is another option. Although most advisers consider this as a last resort, a whole of life policy will ensure that, when you die, the proceeds will be available to cover the IHT bill. "Premiums can be high, especially if you're over 70 or not in good health, so it can be a bit of a balance between whether you pay the insurer or the taxman," explains Alcock.

Although this could be a useful strategy, especially if property is causing your IHT nightmare, do make sure you write the policy in trust. Without this documentation, the proceeds will go straight into your estate where, rather than solving an IHT problem, it will add to the bill.

However you tackle your IHT liability, it's also essential to review your strategy regularly. Making sure your plans are on track every couple of years or if your circumstances change – for example, if you receive a windfall or you get married – will ensure you leave as much as possible to your loved ones rather than the taxman.

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