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How to avoid paying Inheritance Tax

Inheritance Tax is an unavoidable nasty and unfortunately we do have to pay tax on our earnings, our purchases, and our savings and then again when we die. Inheritance tax is charged at 40% on the value of a person's estate over £312,000 (2008 – 2009 tax-year). The HM Revenue & Customs website is a good reference source for more detailed information on inheritance tax.

Inheritance Tax is the tax that is paid on your 'estate'. Broadly speaking this is everything you own at the time of your death, less what you owe. It's also sometimes payable on assets you may have given away during your lifetime. Assets include things like property, possessions, money and investments. But, with careful planning you can minimize the effects of inheritance tax.

1. Draw up a list of your estate. Draw up a list of your combined estate, including property, savings, investments, life insurance, death in service benefits and other possessions. If your total estate comes to more than £312,000, after subtracting any outstanding debts like your mortgage, then inheritance tax will be payable. The HM Revenues & Customs website has a good guide on how to value an estate for inheritance tax purposes.
2. Write a will. If you don’t have a will, then the State decides what happens to your estate. A will can help you avoid paying inheritance tax through careful inheritance tax planning. Speak to a solicitor and get plans in place for what you would like to happen when you pass away. It will be much quicker and easier for your loved ones to sort out your estate if there is a legal document in place. The Direct Gov’s website has a good section on the financial reasons to make a will.
3. Give gifts. Giving away gifts is one of the easiest ways of avoiding inheritance tax. You can give away £3,000 in each tax year without paying Inheritance Tax. You can carry forward all or any part of the £3,000 exemption you don't use to the next year but no further. You can make small gifts, up to the value of £250, to as many people as you like in any one tax year (6 April to the following 5 April) without them being liable for Inheritance Tax, but you can’t combine this with any other inheritance exempt gift.
   Wedding or civil partnership ceremony gifts (to either of the couple) are also exempt from Inheritance Tax up to certain amounts: parents can each give £5,000, grandparents and other relatives can each give £2,500 and anyone else can give £1,000.
   Gifts in excess of the exempt levels could create an inheritance tax liability for up to 7 years, so it’s worth referring to the HM Revenues & Customs website’s customer guide on gifts.
4. Tenants in common. This applies to people who own their own home. Married couples and civil partners can now transfer their inheritance tax allowance to each other, removing the need for them to use tenants in common arrangements. This means that married couples and civil partners can bequeath up to £600,000 tax-free (increasing to £700,000 by 2010). The HM Revenue & Customs website has a good customer guide to inheritance tax and tenants in common.
   These rules do not apply to unmarried cohabiting couples or relatives living together and a tenants in common arrangement can help pass on a property worth up to £600,000 free of inheritance tax. If you own your home as joint tenants, then both of you own the whole of the property, so when one partner dies, the other automatically becomes the sole owner of the home. With tenants in common, you each own a share of the property, typically split 50/50.
   By splitting the home in two, the half belonging to the first partner to die could be passed straight onto their children or any designated beneficiary. As long as the half is worth less than £312,000 [2008/9 rate] then no inheritance tax will be due. When the second partner dies, their half, which is also inherited by children, may also be below the threshold, so again would miss inheritance tax.
5. Trusts. With a tenants in common arrangement your children or beneficiaries could in theory force the sale of the home if they want the cash from their half, for example if a child got divorced, the value of their share will be taken in to account when splitting the assets. You can avoid these problems by willing the first half to a nil rate band discretionary trust with the children as beneficiaries and appointing somebody other than them, such as a trusted friend as a trustee. On the first death, the trust accepts a debt equal to a share of the home worth up to £312,000, which is repaid when the surviving partner dies. In effect the part of the home owned by the deceased is lent to the surviving partner until they die. You will need a solicitor to set up a trust for you. The HM Revenues & Customs website has a good customer guide to discretionary trusts.
6. Tenants in common can also avoid long-term care costs. Tenants in common arrangements can also help with long-term care costs. As long as one of you is still living in your home the council can't include its value in the means test if one of you has to go in to long-term care. With tenants in common, that also applies if the husband or wife still living at home dies while the other is in care, because their share goes in to the trust - the value of the home is still effectively nil. The Telegraph website has a good expert’s view on long-term care costs.
7. Other ways to avoid inheritance tax. Certain types of investments receive preferential treatment (e.g. shares in unquoted businesses or shares quoted on the FTSE AIM). Loan trusts can also be used for people who can’t give away gifts because they need an income and gift trusts can also be used. The HM Revenues & Customs website has more details on these and we would recommend that you seek the services of a good solicitor to help with your inheritance tax planning.
8. Consider taking out life insurance. If after careful inheritance tax planning you still have an inheritance tax liability you can also consider taking out a life insurance policy to cover the cost of any inheritance tax bill. Read our money saving guide to life insurance to find out more.
9. Go skiing! You can always Spend the Kids Inheritance instead of paying the taxman!