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Ten ways to avoid inheritance tax (legally)
July 1, 2014 | By:

Freeze your estate, prepare for probate or invest in woodland are just some ways to keep under the inheritance tax threshold, says Julian Knight, the Independent on Sunday’s personal finance editor

Avoid inheritance tax_Freeze your estate

Freeze your estate: the bigger it is, the bigger your inheritance tax bill

As property prices rise, more and more could fall into the inheritance tax trap and, though we won’t be there to face the tax bill, our loved ones could find they pay dearly. But the great thing about inheritance tax is that it is relatively easy to avoid and all these tactics are perfectly legal and above board.

What is inheritance tax?

Inheritance tax is paid on an estate worth £325,000 or more when somebody dies. It’s also sometimes payable on trusts or gifts made during someone’s lifetime. The amount of tax payable is 40 per cent on the amount over £325,000 (or 36 per cent if the estate qualifies for a reduced rate as a result of a charitable donation). Find out more about valuing an estate, who pays inheritance tax, and exemptions. Here are my ten ways to stay under the tax threshold:

Make gifts in your will

You are allowed to make large gifts of up to £3,000 a year to one person and any number of small £250 gifts. So if you have lots of nieces and nephews then gift away, as all this cash will be deemed as outside your estate when you die and therefore not subject to inheritance tax. You can also give £5,000 on the wedding of a child, so hopefully easing some of the financial pain of your offsprings’ nuptials.

Own your home as tenants in common

If you and your spouse own a home together then you will either do as tenants in common or joint tenants. For inheritance tax purposes it is much better to own it as tenants in common because on your or your partner’s death you can bequeath half the property to, say, a child or someone other than your spouse. This will reduce the size of their estate when they shuffle off this mortal coil. It is one of the biggest IHT avoidance no-brainers out there and lots of people miss it. As a result, when the second death occurs, the whole of the value of the property is included in the estate for inheritance tax purposes.

Get married (it increases your tax allowance)

A big advantage of getting married or being civil partners is that it in effect doubles the amount of money that you can have in your estate before it becomes subject to inheritance tax. At present you can own £325,000 before it becomes subject to IHT but if you’re married, on the death of your spouse their allowance £325,000 will be automatically added to yours. If you combine this with owning a property as tenants in common, then nearly all estates can be made tax efficient so that there is no liability to inheritance tax.

Give away high-value low-income assets

Many tax planners advise their clients in later life to give away major assets, even their own homes. They do so not out of an altruistic urge but instead because it reduces the eventual tax bill. But any assets you give away cease to count as part of your estate after seven years, provided you don’t continue to draw a benefit from them. Therefore, you can’t sign over your home and then still live in it; you have to move out. The key with such gifts is to ensure you can happily do without them. This normally means gifting high-value, low income assets.

Set up a trust for your children

Any asset can be held in trust for a set period of time or until a particular event occurs. Trustees take care of the asset while it is held in trust. This is most commonly used for children; for example, a grandparent leaving money for a child which can only be accessed at age 18. The big tax advantage of a trust is that the assets held within it are not deemed to be part of your estate when you die, so are not subject to inheritance tax. However, trusts are complex legal documents and can be costly to set up, so ensure the assets held within one are worth the set-up costs.

Invest in exempt assets

There are certain assets such as business equipment, woodland and farmland that are exempt from IHT. Some wealthy people have been known to buy whole tracts of woodland in order to reduce their inheritance tax liability.

Make charitable gifts in your will

Gifts to charities and political parties are exempt from inheritance tax. This means, in effect, that any gifts you make are not counted in your estate when calculating IHT liability. Many people feel that at least by giving to charity in their will, the money will be better spent and on a cause they believe in, rather than simply disappearing without trace into the government’s coffers.

Prepare for probate

Sad to say that you will one day kick the bucket and you probably do not have any idea when. It is therefore key to plan ahead for inheritance tax. Tactics such as gifting and building up exempt assets can take a long time to make a real impact. Therefore it is best to act as early as you can and get your estate ready for the grim reaper, and the probate process that follows.

Buy life assurance in trust

If you reckon your estate could be in line for an inheritance tax bill you can probably guess how much it will be. You may want to buy a separate life assurance policy so that your loved ones will receive a lump sum large enough to pay any outstanding inheritance tax bill. However, remember to have the life assurance policy written in trust otherwise the amount paid out will count as part of your estate and inheritance tax could be due on payout, sort of defeating the object of the exercise.

Freeze your estate

In effect this involves bringing all the weapons of inheritance tax planning to bear at the same time, so gifting, building up exempt assets and trusts, all with the aim of ensuring that your estate doesn’t grow any bigger and therefore neither does the eventual tax bill. It can take a lot of careful planning to freeze your estate but it can be effective.