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Guide to inheritance tax

2) Use a trust within a will

The most common way of reducing your IHT bill is to set up a trust.

Trusts themselves are an old Saxon concept. Put simply, they are simply a written arrangement whereby an appointed person is given assets to hold and manage for the benefit of those named in the trust deeds.

Since then, solicitors and accountants have become experts in using trusts to help cut people’s tax bills.

Discretionary trusts are a case in point: take the £1m estate mentioned earlier. What you do is set up something called a “nil rate band discretionary trust”.

• Then, divide your assets before death so that each spouse has half. This includes property, which can be done by registering yourselves as “tenants in common” with a lawyer, instead of being “joint tenants”.

• When one partner dies, the other already has £500,000 on which no IHT is paid. The remaining £500,000 can then be split two ways: £300,000, the “nil rate band” limit goes into a discretionary trust for the children or relatives. The rest goes to the surviving spouse.

This basic scheme means that on the widow’s death, IHT will ultimately be paid on assets £700,000, minus her own estate’s £300,000 nil rate band, a total of £400,000. The tax on this would be £160,000, a saving of £120,000 if the trust had not been set up.

Even if a discretionary trust has not been established by the time of death, the survivor has a two-year window to create a “deed of variation”, changing the terms of their deceased partner's will to benefit their children.

3) Seven-year rule

You “gift” the money or other assets to anyone you like and if you survive for seven years after the gift, it becomes a “potentially exempt transfer”, or PET, and they pay no IHT on it.

If you die before that time your estate pays IHT on a sliding scale, ranging from the full amount in the first three years to 20% of the total bill in year six.

To minimise the effect of death inside those seven years, you simply take out “decreasing” life insurance on the person who made the bequest. It pays out a sum of money over those seven years, equal to the IHT bill you would face.

You or your parents can also use PETs to gift the entire. But if they wanted to keep living in the property they would have to pay you a full market rent over those seven years.

4) Take out life insurance

Set up a life insurance policy to pay out on your death. The policy is set up in trust and is for an amount equal to the amount your estate might otherwise be liable for. Generally, premiums on these policies are paid by those who stand to benefit from your will.

5) Lifetime gifts

You can also make the following tax-free gifts during your lifetime:

• Small gifts of up to £250 each to any number of people.

• Up to £3,000 a year in total gifts to one or more people. If you don't use this allowance in one year, you can carry it forward to the next tax year.

• Gifts on marriage to a bride or groom. Each parent can give £5,000, grandparents or remoter relatives £2,500 and anyone else £1,000.

• Regular gifts made out of normal income.

If inheritance tax is really as voluntary as all that, there’s no need for your dependents to pay as much of it as Hector the Tax Inspector would like them to. These simple steps will hopefully keep more of your estate out his clutches.

More pages

Page 1: Introduction
Page 2: 2) Use a trust within a will

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