Inheritance tax (IHT) is a tax charged on estates worth more than £300,000*. For married couples and civil partners, the threshold has recently been raised to £600,000.
Your estate includes everything you own when you die: your home, possessions, savings, investments and cash, minus your funeral expenses and any debts. It includes a share of anything you owned jointly, and anything you gave away before death but continued to benefit from.
* in the tax year 2007-2008
Will I have to pay inheritance tax?
The number of estates likely to be hit by IHT has risen under the current government because the exemption level has failed to move in line with property inflation. The average house price in England and Wales is currently £183,896*, and in London it is £354,272*.
Your property alone may take you over the inheritance tax threshold; even if your property is worth less than £300,000, it doesn't take much in savings or other assets to tip you over the limit. As house prices fluctuate, it's worth keeping an eye on your estate. Anyone with an investment property portfolio in the UK is almost certain to be liable for the tax.
* According to Land Registry figures September 2007
How is inheritance tax calculated?
The tax is charged only on the part of the estate above the exempt threshold. So if your estate was worth £310,000, there would only be tax to pay on £10,000 - charged at 40%. The tax bill has to be paid before the estate can be settled - this might mean the executor of your estate has to sell off some of the estate assets if there is no cash to cover the tax bill.
Minimise your inheritance tax bill - exemptions and potentially exempt transfers
You can reduce your estate by giving away certain sums of money throughout your life. Most gifts are IHT-exempt, provided you live for seven years after giving them. These gifts are known as 'potentially exempt transfers', because if you die within seven years of giving them, it will still be included in your estate and will be liable for IHT.
These gifts have to be made without reservation, so you cannot give something away and continue to benefit from it. For example, you can't transfer ownership of a rental property but continue to receive the rental income from it. Gifts with reservation are not covered by the seven-year rule.
However, the following gifts are exempt from IHT, whenever you give them:
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wedding gifts of up to £5,000 to each of your children, up to £2,500 to each of your grandchildren and up to £1,000 to anyone else
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up to £3,000 to anyone in a single tax year. You can also carry over a previous tax year's unused allowance
'small gifts' of up to £250 per person to any number of people (except those you've already given cash to under one of the exemptions listed above)
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gifts to spouses or civil partners
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gifts to UK charities
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gifts made for 'national purposes', that is, to certain national institutions
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gifts that are 'normal expenditure out of income'; for example, gifts that are regular and leave the donor with a sufficient income to maintain their usual standard of living.
Inheritance tax planning
Protecting your possessions became more difficult when the Chancellor announced the 'pre-owned assets' tax. This tax, introduced in April 2005, means any asset sheltering from IHT in a trust that you continue to benefit from will trigger an income tax liability instead. The only exceptions are assets you ceased to own before 18 March 1986.
Trusts
You can write life insurance policies and pension death benefits into a ust, provided there is a named beneficiary. However, trusts can be expensive to run and complicated to set up, and you would need the help of a solicitor, accountant or tax specialist.
The Alternative Investment Market
Another method of avoiding IHT is to invest in companies listed on the Alternative Investment Market (Aim). There are qualifying requirements but if you are an experienced investor prepared to take a risk, it could be a sensible plan.
Make the right will
Another way to avoid paying IHT is to make a will leaving assets equal to the tax-exempt threshold directly to your children, leaving your spouse with the residue on which there will be no tax due, no matter how much it is.
This article was last updated on 13 November 2007