Inheritance tax tips: Eight ways to shield your family's wealth

The nation’s most loathed financial levy may be inheritance tax, but it’s a growing cash cow for the government.

Families paid a record £6.1bn in estate taxes last year, up from £729m in the past 12 months.

Experts say rising house prices are partly responsible for driving up estate values.

At the same time, the threshold at which the Inheritance Tax (IHT) takes effect has been frozen at £325,000 since 2009 – and is expected to remain the same until 2025/2026.

It means more ordinary households could be stung by the 40 percent levy, which in the past has only affected wealthier individuals.

It’s no wonder, then, that the topic of IHT has become a hot topic in the Conservative Party leadership contest.

Last week, Liz Truss promised to review the tax if she became prime minister. The promise is a welcome relief to campaigners who say the system is too complicated.

In January 2020, an all-party parliamentary group drafted a white paper calling for reform of the IHT, calling it a “very unpopular tax.” But in the two and a half years since then, nothing has changed.

Currently, IHT is due when the value of your estate exceeds £325,000. Any gifts you make in the seven years prior to your death are considered part of your estate by HMRC.

This is known as the ‘seven year rule’. If you die within this period, the tax will be levied on a sliding scale for the first three years, starting at 40 percent.

Assets left to a spouse or registered partner are exempt. In these cases, your tax-free allowance will be passed on to them, doubling to £650,000.

In addition, if you leave property to a direct descendant, such as a child or grandchild, you will also benefit from the £175,000 ‘main residence nil rate band’.

In total, couples can give up to £1 million to loved ones before inheritance tax is due.

These clumsy lines can make for overwhelming reading. So Money Mail has asked a host of tax experts to share eight tricks to protect your family’s wealth from the IRS….

Give it away now

Tax-free donations up to €3,000 per year are part of your ‘annual exemption’. This can be given to one person or divided among several. Or you can carry over the unused amount for a tax year.

You can also give £250 to as many people as you like each tax year, as long as you haven’t used another allowance to give cash to the same person.

Regular income

The tax authorities do not charge any costs for periodic benefits to survivors from your excess income. This could be “relatively easy,” says Kieran Bowe of The Law Society’s Wills and Shares Committee.

Acceptable forms of income include your retirement or money earned from renting out real estate. There is no limit to how much you give, but it won’t affect your standard of living, so it should only be given after you’ve paid all your other living expenses.

You must be able to demonstrate that these payments have been made regularly – monthly, annually or semi-annually.

They fall under the exemption ‘ordinary expenditure from income’, so not under the seven-year scheme.

wedding gifts

You can donate up to £5,000 to your child’s big day without it being included in your annual gift allowance. You can donate € 2,500 for a grand- or great-grandchild. The surcharge drops to £1,000 for someone else.

Check pension

Any funds that remain within the defined contribution pensions after your death are outside your estate and are exempt from IHT.

However, this is not the case if you have already taken out an annuity.

If you participate in a defined benefit plan, there is no ‘pot’ to pass on, but a provision can be made for a spouse or dependents.

Pensions are “invaluable” for lowering IHT bills, says Anthony Kynaston of asset manager Ash Ridge, so be sure to check your policies regularly.

be charitable

If you donate up to 10 percent of your assets to a charitable organization or political party, the inheritance tax rate on your remaining assets decreases by 40 percent. to 36 pc.

All charitable donations are tax free, so any donations from your estate will lower the IHT bill.

Invest wisely

If you choose to invest in companies listed on the Specialized Alternative Investment Market (AIM), which focuses on smaller, higher-risk companies, you may not owe any tax if you leave within two years of doing the investment dies – instead of seven.

This can be risky as the stock markets are volatile and you could lose money. But John McCaffery, of accountancy firm Alexander & Co, says, “You’d have to have more than 40% to be worse off than ending up with an IHT account.”

life insurance

Life insurance can provide a quick, tax-free payout for your family. The money would normally be part of your estate, but not if you wrote it “in trust.” This allows you to designate one or more beneficiaries who will be paid the full amount upon your death. You can insure your life for the estimated value of your IHT account.

However, the premiums can be high, especially as you get older. You can ask a financial advisor for help making these kinds of arrangements.

Set up a trust

A trust allows you to transfer your assets over time, says Natalie Jaques of asset manager Sanlam. You can put £325,000 of your tax-free assets in a trust – or £650,000 if you combine it with a spouse or civil partner.

The money placed in the trust will not be included in your taxable estate when you die – although it is subject to the seven-year rule. After seven years, you can transfer another £325,000 — or £650,000 as a couple.