How do I reduce inheritance tax (IHT)
Although professional advice is essential for those with very large estates, there are several checks that anyone who is concerned about inheritance tax can make to keep their exposure to a minimum.
But here are five basic ways to reduce the tax your heirs may have to pay:
1. Claim a partner’s unused IHT allowance
Married couples and Civil Partners can boost their IHT-free allowance by claiming any ‘nil-rate band’ their deceased partner has not used. The allowance is currently £325,000 per person. If the first partner has made no use of their nil-rate band (by leaving everything to their spouse, for example), the second partner effectively has a double allowance of £650,000. If the first partner used part of their allowance, the unused proportion is carried over to the second – and applied at the current rate. To claim unused allowance after the second partner’s death use HMRC form IHT 420
2. Reduce your estate by making tax-free lifetime gifts
Gifts made during your lifetime can reduce the size of your estate substantially, but there is a limit to how much you can give away tax-free in a single year. The individual allowance is £3,000. You can carry over any unused portion of this to the following year. Other tax-free gifts include wedding gifts (up to £5,000 if you are a parent of one of the couple, £2,500 if you’re a grandparent), small gifts of up to £250 per recipient, gifts out of income that are normal expenditure and maintenance payments to family or dependent relatives.
3. Reduce your estate by making potentially exempt transfers
Larger lifetime gifts may escape IHT but only if you live for seven years after making them. Known as potentially exempt transfers (PETs), they are added back into your estate if they ‘fail’. The reduction in IHT is on a sliding scale, depending on how long you live after making them. IHT is charged at 40% if you die within three years of making a PET but only 8% if you survive longer than six years but less than the full seven.
4. Insure against inheritance tax
If you think your heirs might be faced with IHT, you can take out a whole of life insurance policy to cover the likely bill. The policy pays out on your death, or that of the last surviving partner if you are a couple. It is important to make sure the policy is ‘written in trust’ for your beneficiaries, so that the money doesn’t form part of your estate and simply boost the IHT liability.
5. Get business property relief
Certain categories of business and business assets may qualify for 100 per cent exemption from inheritance tax after two years. The relief normally applies to a business or an interest in a business (partnership) or to shares in an unlisted company. Shares quoted on the Alternative Investment Market also qualify after you have held them for two years.
If you think that you qualify for such a relief, then it’s best to obtain professional advice.
6. Make gifts to charity
Gifts to charity reduce the size of your taxable estate. From April 2012, they can also reduce the rate of IHT your heirs have to pay. If you give at least 10% of your estate to charity, the rate of tax levied on the rest will be reduced by 10%, from 40% to 36%.