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How to beat the inheritance tax trap

Paloma Kubiak
Written By:
Paloma Kubiak

Inheritance tax bills are likely to keep rising despite new allowances introduced by the government. Here’s how to – legitimately –
beat the IHT trap.

More people are falling into the inheritance tax (IHT) net as around 800,000 homes in Britain are now worth at least a million pounds.

If an estate is worth more than £325,000, IHT of 40% is levied on the excess. However, it is possible to pass on your estate to a spouse or civil partner completely tax free on death, but if left to children or other loved ones, they don’t benefit in the same way.

In April 2017, the government introduced the ‘main residence nil-rate band’ starting at £100,000, increasing £25,000 a year until it reaches £175,000 in 2020.

All in all, this means individual homeowners could pass on an extra £100,000 IHT free, so a total of £425,000 currently, rising to £500,000 by 2020. For couples, the respective amounts are £850,000 and £1m.

Alex Davies, CEO and founder of online investment service, Wealth Club ,said inheritance tax is regularly described as the most unjust and hated of all taxes.

“Despite rules which will create an effective £1m IHT-free allowance for couples by April 2020, overall inheritance receipts are likely to keep going up. However, there are steps you can take to make IHT a voluntary tax, from simply making a will or gifting assets, to setting up a trust or investing in an AIM ISA.

“Be aware that IHT planning can be complex so if you’re unsure ask for advice, but do something about it before it’s too late.”

Top tips to navigate the inheritance tax trap

Davies shares his tips to help you beat the IHT trap:

Make a will

This is the most basic, but often most neglected, form of estate planning. Without a will, your estate will be distributed according to set rules, meaning a larger portion may go to the taxman.

Gift assets during your lifetime

You have an annual £3,000 tax-free gift allowance, known as the annual exemption. If you haven’t used your annual exemption fully in the previous year, you can combine it with your current year’s allowance.

The money is immediately outside your estate so there will be no IHT to pay. You can also give up to £250 each year to however many people you wish (one gift per recipient per year), make a wedding gift, or leave 10% or more of your net estate to a charity, which may enable you to qualify for a reduced inheritance tax rate of 36%.

Make larger gifts

As long as you live for at least seven years after giving money away, there is no limit on how much you can give completely IHT free.

Make full use of your pension allowance

Pensions, including those in drawdown, are free from IHT and can be passed on tax efficiently. So, if you have any allowance left, make use of it.

Set up a trust

Trusts have traditionally been a staple of estate planning, and can be very effective at reducing the estate’s value and therefore the potential IHT charge.

It’s important to note that assets placed in trusts will only fall outside of your estate for IHT purposes if you live for at least seven years after establishing the trust. The related taxes and laws are complicated, however, and any decision you make may be irreversible – you should therefore seek specialist advice if you’re considering this option.

Invest in companies qualifying for Business Property Relief (BPR)

Anyone who owns or invests in a business that qualifies for BPR for at least two years can benefit from full IHT relief. You must still be a shareholder on death though.

Invest in an AIM IHT ISA

ISAs are tax free during your lifetime but when you die, or when your spouse dies if later, they form part of your estate and could be subject to 40% IHT. An increasingly popular but still vastly underused way of getting around this is by investing in certain AIM listed companies which qualify for BPR via your stock and shares ISA.

You must hold the shares for at least two years; after which you could potentially pass on assets to anyone you wish without a penny due in inheritance tax.